Microsoft Word - 5. Coffee (8-20-21 6.32) COFFEE 8/20/2021 6:32 PM THE FUTURE OF DISCLOSURE: ESG, COMMON OWNERSHIP, AND SYSTEMATIC RISK John C. Coffee, Jr.* The U.S. securities markets have recently undergone (or are undergoing) three fundamental transitions: (1) institutionali- zation (with the result that institutional investors now domi- nate both trading and stock ownership); (2) extraordinary own- ership concentration (with the consequence that the three largest U.S. institutional investors now hold twenty percent and vote twenty-five percent of the shares in S&P 500 compa- nies); and (3) the introduction of ESG disclosures (which has been driven in the U.S. by pressure from large institutional in- vestors). In light of these transitions, how should disclosure policy change? Do institutions and retail investors have the same or different disclosure needs? Why are large institutions pressing for increased ESG disclosures? This Article will focus on the desire of institutions for greater ESG disclosures and suggest that two reasons underlie this demand for more information: (1) ESG disclosures overlap substantially with systematic risk, which is the primary con- cern of diversified investors; and (2) high common ownership enables institutions to take collective action to curb externali- ties caused by portfolio firms, so long as the gains to their port- folio from such action exceed the losses caused to the external- ity-creating firms. This transition to a portfolio-wide perspective (both in voting and investment decisions) has sig- nificant implications but also is likely to provoke political con- troversy. In its final hours, the Trump Administration adopted new rules that discourage voting based on ESG criteria and thus by extension chill ESG investing. This controversy will continue. * Professor Coffee is the Adolf A. Berle Professor of Law at Columbia University Law School and Director of its Center on Corporate Governance. COFFEE 8/20/2021 6:32 PM No. 2:602] THE FUTURE OF DISCLOSURE 603 As more institutions shift to portfolio-wide decisionmaking, there is an optimistic upside: externalities may be curbed by collective shareholder action. For entirely rational reasons, the new “universal” shareholders who now dominate the market will resist even large public companies who might seek to im- pose externalities on other companies. Owning the market, the “universal” shareholder will protect the market. Still, this pro- cess of resistance may produce frictions, and the disclosure needs of individual investors and institutional investors will increasingly diverge. Of course, not all institutional investors are indexed or even diversified, but those that remain undiver- sified (for example, hedge funds) logically have the perspective of an option-holder and favor greater risk-taking. Across the board, retail investors have different perspectives and prefer- ences than do institutional investors. Above all, the combination of high common ownership and institutional sensitivity to systematic risk makes disclosure a far more powerful force. If disclosure was once Brandeis’s best disinfectant, it is now becoming a force that can effect signifi- cant social and economic change without the need for judicial or agency intervention. I. Introduction ............................................................... 604 II. The Informational Needs of the Institutional Investor: How Are They Different ............................................. 615 III. The Retail Investor: The Relevance of Option Pricing Theory and Common Ownership ............................... 622 A. Activism and Option Pricing Theory ................... 622 B. Common Ownership and the Undiversified Retail Investor ................................................................ 629 IV. The Special Case of ESG Disclosures: Can Fiduciaries Lawfully Use This Information? ................................ 630 A. A Brief History of ESG ........................................ 631 B. The Remaining Legal Uncertainty ..................... 634 C. The Impact of a Portfolio-Wide Perspective........ 636 D. Investment Versus Voting Decisions .................. 641 E. The Coming Controversy over Portfolio-Wide Decisionmaking ................................................... 646 V. Conclusion .................................................................. 647 COFFEE 8/20/2021 6:32 PM 604 COLUMBIA BUSINESS LAW REVIEW [Vol. 2021 I. INTRODUCTION How should the norms of corporate governance and disclo- sure policy change (at the SEC and elsewhere) in light of new market conditions and a changing population of shareholders? So framed, this may seem a fairly narrow question, which as- sumes that one accepts the need for a mandatory disclosure system.1 Yet, once over that first hurdle, a second question logically follows that is broader and more nuanced: Do all in- vestors have the same informational needs and goals? Or do some have distinctive needs and preferences? This Article will suggest that individual and institutional investors have dif- ferent needs (largely based on their level of diversification) and that conflicts can arise between them. Diversified institutional investors are beginning to make voting and investment decisions on a portfolio-wide basis in- stead of on a stock-by-stock basis. This is a product of the growth in indexed investing and the high level of common ownership among such indexed investors, but it implies in turn that we may be moving from a system of corporate gov- ernance that is premised on a “shareholder primacy model” to a system that is premised on a “portfolio primacy model.”2 In the future, our largest institutions may knowingly accept, and even cause, losses at some firms in their portfolios if they 1 Because this topic has been debated at length elsewhere, it will be sidestepped here. For defenses of a mandatory disclosure system, see gen- erally John C. Coffee, Jr., Market Failure and the Economic Case for a Man- datory Disclosure System, 70 VA. L. REV. 717 *1984) (finding such a system is a cost-effective subsidy and produces positive externalities); Merritt B. Fox, Retaining Mandatory Securities Disclosure: Why Issuer Disclosure Is Not Investor Empowerment, 85 VA. L. REV. 1335 (1999). 2 This idea of a “portfolio primacy model” should not be confused with a “stakeholder primacy model,” which has been supported by many com- mentators who want boards and managers to balance the interest of other stakeholders in the corporation with those of shareholders. A focus on max- imizing the value of the portfolio is quite different from a focus on sustain- ability or wealth transfers to stakeholders (even though the two perspec- tives may overlap). COFFEE 8/20/2021 6:32 PM No. 2:602] THE FUTURE OF DISCLOSURE 605 expect that those losses will be outweighed by correlative gains at other portfolio firms. One cannot assess this topic without recognizing that we have moved far away from the environment in which the SEC grew up. In fact, three distinct and important transitions are in progress, but each is at a very different stage. First and most obvious, the “institutionalization” of the market has now been fully realized. Historically, the SEC has always seen its interests as closely aligned with those of the retail investor.3 It has proclaimed itself “the investors’ advo- cate,”4 and public investors have in turn recognized and ap- plauded the SEC’s efforts. This mutual alliance gave the SEC relative political immunity and assured it reasonable budget- ary appropriations, despite major swings in policy and times of great stress for other agencies over recent decades.5 3 For this conclusion, see generally JOEL SELIGMAN, THE TRANSFOR- MATION OF WALL STREET: A HISTORY OF THE SECURITIES AND EXCHANGE COM- MISSION AND MODERN CORPORATE FINANCE (3d ed. 2003). 4 Professor Donald Langevoort opens an excellent article dealing with the transition from a retail to an institutional market (and its implications for the SEC) by observing correctly in his first sentence: “The Securities and Exchange Commission thinks of itself as the investors’ advocate[.]” Donald C. Langevoort, The SEC, Retail Investors, and the Institutionalization of the Securities Markets, 95 VA. L. REV. 1025, 1025 (2009). This phrase also ap- pears regularly on the SEC’s website. See, e.g., Kara M. Stein, Comm’r, U.S. Sec. & Exch. Comm’n, Remarks at the SEC’s Investor Advisory Committee Meeting (Mar. 8, 2018) (quoting William O. Douglas, Chairman, U.S. Sec. & Exch. Comm’n, Address at the Dinner of the Association of Stock Ex- change Firms at the Commodore Hotel 3 (May 20, 1938)), https://www.sec.gov/news/public-statement/statement-stein-2018-3-8 [https://perma.cc/MZ8F-6J44]. 5 I do not mean that the SEC always got what it wanted (or needed), but in comparison to other “consumer protection” agencies, including the Commodities Futures Trading Commission and the more recent Consumer Financial Protection Bureau, it has done relatively well. See SELIGMAN, su- pra note 3, at xviii–xxi (discussing the twentieth century). I attribute this not to uniformly brilliant leadership at the SEC, but to the fact that Con- gress knows the SEC is popular with individual investors (and voters) in their jurisdiction. Cf. Harvey J. Goldschmid, Keynote Address, The SEC at 70: Let’s Celebrate Its Reinvigorated Golden Years, 80 NOTRE DAME L. REV. 825, 831–33 (2005) (defending the SEC’s responsiveness to public concerns). Here, it is also noteworthy that institutional investors do not vote. COFFEE 8/20/2021 6:32 PM 606 COLUMBIA BUSINESS LAW REVIEW [Vol. 2021 But that is past. The era in which retail investors “owned” companies or moved the trading markets is long gone and “deader than disco.” Today, retail investors account for only a modest minority of the ownership of large, publicly traded companies and probably only around 4% of the trading in NYSE-listed companies.6 Stock ownership is now dominated by institutional investors, who are increasingly diversified and often indexed.7 The second transition involves the more recent and ex- traordinary concentration in stock ownership, with the result that as few as five to ten institutions today may be in a 6 The level of institutional ownership increases with the size of the com- pany’s market capitalization (as institutions desire liquidity and thus con- centrate on large cap stocks). Thus, if we look at the market value of all outstanding, publicly traded equity securities in the United States, institu- tions have owned over 62% for a number of years. See KATIE KOLCHIN & JUSTYNA PODZIEMISKA, SEC. INDUS. & FIN. MKTS. ASS’N., 2019 CAPITAL MAR- KETS FACT BOOK 73 tbl.U.S. Holdings of Equities (2019) (percentages ranged between 64.7% and 62.4% from 2008 to 2018). If, however, we look at the U.S. companies that are among the 10,000 largest companies in the world, this percentage rises to 72% according to a recent OECD report. ADRIANA DE LA CRUZ, ALEJANDRA MEDINA & YUNG TANG, ORG. FOR ECON. COOP. & DEV., OWNERS OF THE WORLD’S LISTED COMPANIES 11 tbl. 3 (2019). For the level of trading in publicly listed equities by retail investors, a recent estimate is 3.68% (based on data from 2010 to 2015). See Ekkehart Boehmer et al., Tracking Retail Investor Activity, J. FIN. (forthcoming) (man- uscript at 8) (on file with the Columbia Business Law Review), https://pa- pers.ssrn.com/sol3/papers.cfm?abstract_id=2822105. For an earlier esti- mate of 2% for trading by individual investors, see Alicia Davis Evans, A Requiem for the Retail Investor?, 95 VA. L. REV. 1105, 1105 (2009). In 2020, the percentage of trading by retail investors saw some increase as the result of market strategies adopted by Robinhood Markets, Inc. and other online brokers, but it remains to be seen whether this is more than a short-term phenomenon. See Caitlin McCabe, Retail Investors Pull Back Trading Ac- tivity, WALL ST. J., Apr. 5, 2021, at A1. 7 “Indexing,” or “indexed investing” refers to a passive investment strategy under which the investor invests in a broad market index (such as, for example, the S&P 500 index), seeking not to outperform the market, but only to match it. As later discussed, much empirical research strongly sug- gests that retail investors cannot outperform the market and that they lose money systematically when they attempt to do so. Indexed investing also reduces trading costs, as it is a “buy and hold” policy, which can minimize tax liabilities. COFFEE 8/20/2021 6:32 PM No. 2:602] THE FUTURE OF DISCLOSURE 607 position to exercise de facto control over even large public cor- porations. The Big Three institutional investors—BlackRock, Inc., State Street Global Advisors, and the Vanguard Group— now hold over 20% of the shares in S&P 500 companies, vote approximately 25%, and are projected to vote over 40% by 2038.8 Potentially, this might suggest that retail investors are exposed to domination by institutional control groups,9 but such a thesis still seems premature. At first glance, little con- flict is apparent between diversified institutions and retail 8 This difference between 20% and 25% reflects the fact that many shares are not voted. For these percentages and for their prediction that the votes cast by the Big Three will rise eventually to 40% or more, see Lucian Bebchuk & Scott Hirst, The Specter of the Giant Three, 99 B.U. L. REV. 721, 724 (2019). To give an example of activism in action, just six shareholders control 24% of ExxonMobil; the same six control 26% of Chevron; and they have pressured both companies regarding emissions and climate change. Madison Condon, Externalities and the Common Owner, 95 WASH. L. REV. 1, 10–11, 24 & n.116 (2020). These six included the foregoing Big Three and Northern Trust, Bank of America, and Capital Research Global Investors. Id. at 10 n.38. The stock in publicly held companies (in terms of asset values) that is held by the ten largest mutual funds (not all of which are index funds) rose from 46% in 2005 to 64% in 2019, and the corresponding per- centages held by the five largest such funds grew from 35% in 2005 to 53% in 2019. See INV. CO. INST., INVESTMENT COMPANY FACTBOOK 46, fig.2.14 (60th ed. 2020). 9 Much of the literature that is concerned about the growing concentra- tion of shares in the hands of a limited number of institutional owners has focused on the danger that such concentration will be anticompetitive, lead- ing to shareholder pressure in some industries for firms not to compete. See Einer Elhauge, Horizontal Shareholding, 129 HARV. L. REV. 1267, 1268–69 (2016); José Azar, Martin C. Schmalz & Isabel Tecu, Anticompetitive Effects of Common Ownership, 73 J. FIN. 1513, 1514 (2018). However, the flip side of this coin is that institutions can use their collective power to induce their portfolio companies to behave in a more socially responsible manner (at least when it will benefit their portfolio on a net basis). In particular, con- centrated owners can balance the gains caused to some companies in their portfolio by shareholder activism that restricts or discourages externalities that injure them against the losses experienced by the externality-causing firms in the same portfolio. Although it cannot be assumed that the poten- tial gains will necessarily exceed the potential losses, when they do, it is good business policy to force the internalization of the externalities by the firms causing them. See Condon, supra note 8, at 10–11. COFFEE 8/20/2021 6:32 PM 608 COLUMBIA BUSINESS LAW REVIEW [Vol. 2021 investors, as indexed institutions are not seeking control.10 Still, a potential conflict may be developing: as diversified in- stitutional investors, utilizing their power of common owner- ship, begin to make decisions on a portfolio-wide basis (delib- erately pursuing strategies that boost the stocks of some firms in their portfolios, while depressing the stocks of others to achieve a net gain), they will be taking actions contrary to the interests of undiversified investors in those firms on which they impose losses. Eventually, this conflict will trigger con- troversy and may necessitate compromises. Meanwhile, retail investors have moved their investments from “actively managed” (or “stock-picking”) mutual funds to more passive index funds.11 Collectively, retail investors seem to have finally recognized that they are poor stock pickers who systematically lose money when they trade actively on their own.12 As a result, they have migrated in large numbers to invest in highly diversified institutional intermediaries (led by the Big Three), thereby further increasing ownership con- centration.13 10 For a discussion of constraints on institutional control, see Jill Fisch, Assaf Hamdani & Steven Davidoff Solomon, The New Titans of Wall Street: A Theoretical Framework for Passive Investors, 168 U. PA. L. REV. 17, 61–64 (2019). 11 In 2019, index funds (i.e., mutual funds that track a broad market index) for the first time exceeded traditional stock-picking funds, holding $4.27 trillion in assets as compared to $4.25 trillion for traditional stock- picking funds. Dawn Lin, Index Funds Are The New Kings Of Wall Street, WALL ST. J., (Sept. 18, 2019, 5:30 AM) (on file with the Columbia Business Law Review), https://www.wsj.com/articles/index-funds-are-the-new-kings- of-wall-street-11568799004; see also generally Fisch et al., supra note 10. 12 The simple truth is that only a small minority of actively managed funds have outperformed passive index funds. In his Presidential Address to the American Economics Association, Professor Kenneth R. French as- sembled data showing that, over the period from 1980 to 2006, a passive investor would have on average beaten an actively-trading investor by over sixty-seven basis points per year. Kenneth R. French, Presidential Address, The Cost of Active Investing, 63 J. FIN. 1537, 1561 (2008). 13 While the Big Three now hold over 20%, some estimate that they will hold 40% or more of the shares in the S&P 500 within two decades. See Bebchuk & Hirst, supra note 8, at 740 fig.3, 741. COFFEE 8/20/2021 6:32 PM No. 2:602] THE FUTURE OF DISCLOSURE 609 Finally, the third important transition involves a new de- mand among investors (particularly among diversified insti- tutional investors) for a new category of information, known as “ESG” disclosures (ESG is an acronym that stands for “en- vironmental, social, and governance”).14 Investors who pursue “ESG investing” tend to focus heavily on the environmental and social impact of the firm and on its human capital (includ- ing the level of racial and gender diversity at the firm).15 Alt- hough it may be clear why social activists want to encourage such socially relevant disclosures, it puzzles many why diver- sified institutional investors have been the strongest propo- nents of increased ESG disclosure.16 This Article argues that this development is neither strange nor the product of the po- litical sympathies of individual fund managers, but is the con- sequence of a fundamental economic logic. Put simply, their interest in ESG disclosures flows directly both from the Capi- tal Asset Pricing Model (CAPM)17 and from the just-noted fact 14 Many believe that trustees and other fiduciaries “have come under increasing pressure to use environmental, social, and governance (ESG) fac- tors in their investment decisions.” See Max M. Schanzenbach & Robert H. Sitkoff, Reconciling Fiduciary Duty and Social Conscience: The Law and Economics of ESG Investing by a Trustee, 72 STAN. L. REV. 381, 384 (2020). Although there may be pressure (particularly in the case of public pension funds, which are politically accountable), this Article will assert that sound economic reasons better explain why fiduciaries at large diversified inves- tors favor ESG principles, and thus why ESG investing is likely to increase for reasons unrelated to political pressure. Interestingly, journalists report that while European oil companies have been pressured by their govern- ments to incorporate ESG criteria into their decisionmaking, the pressure on U.S. oil companies for the same outcome has come exclusively from large institutional investors (and not at all from the government). See Stanley Reed, Europe’s Oil Titans Ramp up Transition to Cleaner Energy, N.Y. TIMES, Aug. 17, 2020, at B1. 15 For a similar description of ESG investing, see Schanzenbach & Sitkoff, supra note 14, at 388. 16 Anecdotal evidence is abundant that diversified institutional inves- tors, including the Big Three, are placing significant pressure on many com- panies, particularly including energy companies to expedite their dates for “carbon-neutrality” and on all companies to achieve greater board diversity. See generally Condon, supra note 8; Reed, supra note 14. 17 For the original statement of this model, see generally William F. Sharpe, Capital Asset Prices: A Theory of Market Equilibrium Under COFFEE 8/20/2021 6:32 PM 610 COLUMBIA BUSINESS LAW REVIEW [Vol. 2021 of their high common ownership in portfolio companies. Both of these factors imply that diversified investors should ration- ally concentrate on systematic risk and generally disregard idiosyncratic risk. Indeed, the best evidence that these diver- sified investors are conforming to economic logic lies in a new pattern under which they are actively voting and lobbying public companies in common, primarily on ESG-related is- sues.18 Given high common ownership across a broad portfolio, it becomes rational and predictable that diversified institutional investors will increasingly make both investment and voting decisions on a portfolio-wide basis (rather than simply trying to maximize the value of individual stocks). Proposals made by a diversified institutional investor to the firms in its port- folio will likely produce some winners and some losers, partic- ularly for proposals relating to climate change and other ESG issues. If netting these gains and losses produces a positive result, the indexed investor profits in a way that the undiver- sified investor cannot duplicate. These opportunities are most likely to arise with respect to ESG issues. The implications of this strategy are sweeping, controversial, and possibly as ad- verse to the interests of retail investors as they are advanta- geous to the interests of large diversified investors.19 How should the SEC respond (if at all) to these transitions? Some will argue that the SEC should keep the protection of Conditions of Risk, 19 J. FIN. 425 (1964); John Lintner, The Valuation of Risk Assets and the Selection of Risky Investments in Stock Portfolios and Capital Budgets, 47 REV. ECON. & STAT. 13 (1965). 18 See generally Elroy Dimson, Oğuzhan Karakaş & Xi Li, Coordinated Engagements (Eur. Corp. Governance Inst. Working Paper No. 721/2021, Jan. 2021) (on file with the Columbia Business Law Review), https://ssrn.com/abstract=3209072 (finding an “international network of long-term shareholders cooperating to influence firms on environmental and social issues”). 19 What is new here is that large institutional investors can profit by deliberately causing losses to some firms in their portfolios if doing so re- sults in greater gains to other firms in their portfolio. Although non-control- ling shareholders have never owed a duty of loyalty to the corporations in which they invest, it is hard to think of any comparable instance in which causing losses to some fellow shareholders could benefit them. COFFEE 8/20/2021 6:32 PM No. 2:602] THE FUTURE OF DISCLOSURE 611 the retail investor as its first priority, but this Article is prem- ised on the belief that the migration of retail investors to in- dexed investing has been salutary. In fact, the SEC should en- courage (and even gently push) retail investors to diversify, shifting their retirement savings to diversified (and, gener- ally, indexed) institutional intermediaries (i.e., mutual funds and pension funds). Still, this preference leaves unanswered our initial question: How do the informational needs of insti- tutional investors and retail investors differ? How should the SEC respond to their differing needs? This question has been approached by others but not di- rectly answered. A dozen years ago, Professor Donald Lange- voort focused on the transition from retail to institutional markets at the time of the SEC’s seventy-fifth anniversary.20 His recommendations seemed to suggest that the U.S. market would probably become more like the European securities market, which, as he accurately observed, was characterized by (1) “light touch” enforcement, (2) a lesser disclosure burden emphasizing principles-based disclosure, and (3) considerably less reliance on ex post litigation to enforce disclosure norms.21 Others challenged him,22 but the greater problem with Professor Langevoort’s thesis was his unfortuitous tim- ing. Shortly after he wrote, the 2008 financial crisis broke, and, in response, even the United Kingdom abandoned “light touch” regulation. While differences in enforcement intensity still separate the United States and Europe (and will likely 20 See Langevoort, supra note 4. 21 See id. at 1032–42. 22 See generally Evans, supra note 6. COFFEE 8/20/2021 6:32 PM 612 COLUMBIA BUSINESS LAW REVIEW [Vol. 2021 continue),23 a greater consensus exists today over the need for stronger enforcement24 and a mandatory disclosure system.25 This Article will therefore skirt the topic of enforcement and instead focus on where the disclosure needs of retail and institutional investors may differ and where they are not be- ing addressed. Here, other transitions in securities law prac- tices are also relevant. Increasingly, private offerings, which are exempt from the Securities Act of 1933 (the “1933 Act”), have come to rival public offerings as a means for issuers to raise capital. Indeed, in recent years the number of private offerings and the total capital raised in them has exceeded the corresponding figures for public offerings subject to the 1933 Act.26 Because these exempt offerings require little disclosure (at least as a legal matter),27 this might seem to imply that 23 For a detailed examination of relative enforcement intensity between the U.S., the U.K., and Europe, see generally John C. Coffee, Jr., Law and the Market: The Impact of Enforcement, 156 U. PA. L. REV. 229 (2007). 24 See, e.g., generally Hans B. Christensen, Luzi Hail & Christian Leuz, Mandatory IFRS Reporting and Changes in Enforcement, 56 J. ACCT. & ECON. 147 (2013) (emphasizing the link between enforcement quality and liquidity benefits); see also Coffee, supra note 23. 25 See, e.g., Andrew A. Schwartz, Mandatory Disclosure in Primary Markets, 2019 UTAH L. REV. 1069, 1072 (observing, despite objections to the consensus, that “[n]early all scholars support” mandatory disclosure). 26 The principal exemption for private placements is Regulation D. 17 C.F.R. §§ 230.500–.08 (2020). The number of “Reg D” offerings has exceeded the number of public equity offerings by a thirty-to-one margin. See JOHN C. COFFEE, JR., HILLARY A. SALE & M. TODD HENDERSON, SECURITIES REGU- LATION: CASES AND MATERIALS 368 tbl.Number of Offerings by Type of Offer- ing and Year (13th ed. 2015). The aggregate amount raised in private mar- kets has also exceeded that raised in public markets in some years. For example, in 2012, $1.7 trillion was raised in private markets versus $1.2 trillion in public markets in registered offerings. Id. at 368. 27 Under Rule 502(b) of Regulation D, the issuer need not provide in- formation to purchasers when selling to “accredited investors.” 17 C.F.R. § 230.502(b). Typically, such offerings are, as a result, limited to “accredited investors,” which term is defined in Rule 501 of Regulation D to require only a modest $1 million net worth or an annual income for the two most recent years equal to or exceeding $200,000. See 17 C.F.R. § 230.501(a)(5)–(6). With inflation, this test has become much more permissive and now includes mil- lions of investors. As a generalization, the purchasers in Reg D offerings are generally individuals and smaller institutions, and the disclosure they COFFEE 8/20/2021 6:32 PM No. 2:602] THE FUTURE OF DISCLOSURE 613 institutional investors need less information. Yet a confound- ing fact interferes with this simple conclusion: the character of the disclosure actually provided in offerings done pursuant to Rule 144A (the exemption from registration preferred by large public issuers)28 closely resembles the character of the information in a registration statement filed pursuant to the 1933 Act. In particular, the issuer’s disclosures in a Rule 144A offering typically follow the same standardized format. Alt- hough no precise metric exists that proves that the same quantum of information is present in both exempt and regis- tered offerings, institutional investors as a group appear to want (and implicitly demand) at least the same information as other investors, and they prefer it presented in the same standardized format. Particularly as they come to make deci- sions on a portfolio-wide basis, diversified institutions will in- creasingly want to know and compare the likely impact of ESG-related policy changes on all firms in their portfolio. In contrast, undiversified shareholders, lacking common owner- ship, are not in a position to make similar inquiries or imple- ment similar portfolio-wide policies. This Article will offer a number of conclusions that are brief and blunt; to be brief, it is necessary to be blunt. Organ- izationally, Part II of this Article will focus on the informa- tional needs of institutional investors (and particularly the fully diversified institutions). How do their needs and priori- ties differ from those of the retail individual investor? Relying receive tends to be quite modest. Cf. SCOTT BAUGUESS, RACHITA GULLAPALLI & VLADIMIR IVANOV, U.S. SEC. & EXCH. COMM’N, CAPITAL RAISING IN THE U.S.: AN ANALYSIS OF THE MARKET FOR UNREGISTERED SECURITIES OFFERINGS, 2009-2017, at 34 tbl.11 (finding an average of fourteen investors per Regu- lation D offering from 2009 to 2017). 28 See Rule 144A, 17 C.F.R. § 230.144A. This rule permits private sales to institutional buyers that own and invest at least $100 million in securi- ties of unrelated issuers (in short, the profile of a large institutional inves- tor). Id. § 230.144A(a)–(c). The volume and quality of the disclosure in Rule 144A offerings is much higher than in Reg D offerings to smaller investors, suggesting that large institutions are demanding more information based on their market power. See Elisabeth de Fontenay, Do the Securities Laws Matter? The Rise of the Leveraged Loan Market, 39 J. CORP. L. 725, 766–67 (2014). COFFEE 8/20/2021 6:32 PM 614 COLUMBIA BUSINESS LAW REVIEW [Vol. 2021 on the CAPM, it will suggest, first, that institutional investors are more concerned with “systematic risk” than are individual investors29 and, second, that ESG disclosures address system- atic risk to a much greater degree than the SEC has recog- nized. Part III will then return to the individual retail investor, who certainly remains on the scene and is the dominant in- vestor in smaller companies that offer less liquidity. What new needs (and fears) might the retail investor reasonably have in the contemporary investment environment? Here, a partial answer will be that, although diversified institutions tend to be tolerant of risk, individual investors rationally have the reverse preference. Finally, Part IV will turn to the growth of ESG disclosures. Although such disclosures are now becoming mandatory in Europe, they remain optional and voluntary in the United States, with the SEC having stubbornly avoided (at least prior to the Biden administration) taking any firm (or even coher- ent) position on ESG disclosures.30 This Article seeks both to 29 The claim here is not that individual investors disregard or ignore systematic risk, but that they are unable to do much about it. Lacking high common ownership, they cannot take meaningful collective action. Alt- hough portfolio firms may face different degrees of systematic risk, the re- tail investor also has choices with regard to a vast range of companies with differing idiosyncratic risks and thus have less reason to focus dispropor- tionately on systematic risk. 30 The SEC has not implemented any mandatory ESG disclosure re- quirements, leaving them entirely voluntary. For a critical evaluation of the SEC’s positions, see Thomas Lee Hazen, Social Issues in the Spotlight: The Increasing Need To Improve Publicly-Held Companies’ CSR and ESG Dis- closures, 23 U. PA. J. BUS. L. (forthcoming 2021) (manuscript at 6–7) (on file with the Columbia Business Law Review), https://papers.ssrn.com/ab- stract_id= 3615327. Nonetheless, it is abundantly clear that the SEC, under the Biden admin- istration and new Chairman Gary Gensler, has made the promulgation of ESG disclosure standards a priority. For a recent overview, predicting that new ESG standards will appear in 2021, see K&L Gates LLP, SEC To Move Quickly on ESG Disclosures, JD SUPRA (May 17, 2021), https://www.jdsu- pra.com/legalnews/sec-to-move-quickly-on-proposed-esg-9700856/ [https://perma.cc/YKJ5-FJBA]. This Article will not attempt to assess rules that have not yet been drafted. COFFEE 8/20/2021 6:32 PM No. 2:602] THE FUTURE OF DISCLOSURE 615 explain the strong interest of diversified institutions in ESG disclosures and the obstacles that exist under current law to the use of such information by certain fiduciaries. This leads to a final question: How should the SEC assist, encourage, or otherwise influence this process? II. THE INFORMATIONAL NEEDS OF THE INSTITUTIONAL INVESTOR: HOW ARE THEY DIFFERENT? It is traditional to begin any discussion that relies on “law and economics” with the mandatory observation that “one size does not fit all.” Not all institutional investors are alike. Some mutual funds and many hedge funds are “stock pickers;” they engage in active trading and believe they can outperform the efficient market. Generally, they are wrong,31 but not invari- ably (which could be explained by the fact that some may have access to private information). Today, highly diversified insti- tutional investors have more assets under their management than do institutions engaged in “actively managed” stock pick- ing.32 Typically these highly diversified investors do not at- tempt to outperform the market, but rather to mirror it cheaply.33 Given their dominance, it is prudent to ask: What kinds of information does the fully diversified investor want? Here, one needs to turn to the CAPM, and its most relevant teaching for our purposes is that diversification reduces “idiosyncratic” risk but not “systematic” risk.34 Idiosyncratic risk (or non-sys- tematic risk) is the risk that is unique to a company or indus- try; for example, a company’s (or an industry’s) technology may be outdated or outperformed by a new emerging technol- ogy (e.g., natural gas or solar power may become cheaper than 31 See supra note 12. 32 See supra note 11. 33 For a discussion of index investing and its possibilities, see Byung Hyun Ahn, Jill E. Fisch, Panos N. Patatoukas & Steven Davidoff Solomon, Synthetic Governance, 2021 COLUM. BUS. L. REV. 476. 34 For a concise discussion of this difference in the standard finance textbook, see RICHARD A. BREALEY, STEWART C. MYERS & FRANKLIN ALLEN, PRINCIPLES OF CORPORATE FINANCE 178–81 (13th ed. 2020). COFFEE 8/20/2021 6:32 PM 616 COLUMBIA BUSINESS LAW REVIEW [Vol. 2021 oil- or coal-based power). But some risks affect all companies: inflation may increase; a banking crisis may disrupt finance and cut off credit across the economy; or, more recently, a pan- demic may require all companies to curtail or suspend opera- tions. Diversification does not offer satisfactory protection from these risks. The CAPM assumes that the capital markets ignore non- systematic risk in pricing the value of a financial asset (in- cluding corporate stock) because diversified investors do not bear that risk.35 Because diversification is easily achieved with little cost or effort for investors, the price of a stock, ac- cording to this model, is set by diversified investors, who need only consider the company’s systematic risk. In effect, if two companies have the same expected return, the fact that one has higher non-systematic risk will not affect their relative valuation to the extent the market price is set by diversified investors who do not bear this risk. Put differently, investors cannot demand a higher return for bearing non-systematic risk that they could have easily diversified away. The key implication here is that the price of a financial as- set will be determined by the asset’s systematic risk compared to the risk of the market as a whole. To be sure, the CAPM has been much criticized and may overstate its case.36 But, even its critics believe that it points in the right direction and is roughly accurate.37 The CAPM’s immediate implication for our topic of disclosure policy is that, as the market becomes increasingly populated by diversified investors, these inves- tors will focus primarily on systematic risk. Individual inves- tors may have some concern about systematic risk, but it does not dominate their intentions because there is little they can 35 Id. at 207. 36 For such a critique, see Eugene F. Fama & Kenneth R. French, Com- mon Risk Factors in the Returns on Stocks and Bonds, 33 J. FIN. ECON. 3, 4–5 (1993) (finding the CAPM to be empirically inadequate). 37 In a series of articles, Fama and French proposed supplementing the original CAPM with a few additional factors. See generally Eugene F. Fama & Kenneth R. French, A Five-Factor Asset Pricing Model, 116 J. FIN. ECON. 1 (2015). Thus, although they believe the CAPM needs to be supplemented, they do not reject it as a starting point. COFFEE 8/20/2021 6:32 PM No. 2:602] THE FUTURE OF DISCLOSURE 617 do about it, and they have a range of other choices. Unsurpris- ingly, the SEC, as an agency that has always served the retail investor, has never addressed systematic risk in anything ap- proaching a comprehensive manner.38 Let us assume that the CAPM makes assumptions that many will regard as overstated.39 Even if we need to take it with a substantial grain of salt, the CAPM still legitimately implies that the SEC needs to modernize its disclosure policy and focus more seriously on systematic risk. This does not mean that the SEC should ignore non-systematic risk (be- cause many investors will remain less than fully diversified), but it does suggest that diversified investors, who constitute a majority of the market, have an unmet disclosure need. What has the SEC done to this point with regard to ESG disclosures? The short answer is very little. In 2018, institu- tional investors representing over $5 trillion in assets under management submitted a rulemaking petition to the SEC re- questing it to mandate ESG disclosure standards for public companies.40 “[M]ore than 60 governments and international [organizations], including the United Nations . . . [and] the In- ternational Organization of Securities Commissions,” have promulgated ESG standards,41 but the SEC has resisted these pressures (probably motivated by countervailing pressures from corporate issuers). The SEC’s principal expressed con- cern has been the danger of information overload that would inundate investors with low-quality information and often in- consistent metrics and rankings.42 To date, the SEC’s only 38 For a discussion of some of the pressures against comprehensive reg- ulation of systematic risk from the financial sector, see John C. Coffee, Jr., Systemic Risk After Dodd-Frank: Contingent Capital and the Need for Reg- ulatory Strategies Beyond Oversight, 111 COLUM. L. REV. 795, 818–22 (2011). 39 See supra notes 36–37 and accompanying text. 40 For a fuller description, see Virginia Harper Ho & Stephen Kim Park, ESG Disclosure in Comparative Perspective: Optimizing Private Or- dering in Public Reporting, 41 U. PA. J. INT’L L. 249, 253 (2019). 41 Id. at 252–54 (footnotes omitted). 42 For an evaluation of this danger and an answer to it, see generally Virginia Harper Ho, Disclosure Overload?: Lessons for Risk Disclosure and ESG Reporting in the Regulation S-K Concept Release, 65 VILL. L. REV. 67 (2020). COFFEE 8/20/2021 6:32 PM 618 COLUMBIA BUSINESS LAW REVIEW [Vol. 2021 real action has been to update its standards under Regulation S-K (which specifies the disclosures mandated in SEC fil- ings),43 but here it has limited itself to extremely general “principles-based disclosures.”44 Meanwhile, the largest U.S. institutional investors (including the Big Three) have gone well beyond adopting general policies and have directly en- gaged major companies on climate change issues and have even sued them.45 43 17 C.F.R. §§ 229.1–.1406 (2020). 44 In 2020, the SEC “modernized” its requirements with respect to Items 101, 103 and 105 of Regulation S-K but required only very general “principles-based” disclosures. For example, with respect to Item 101 (which requires a description of the issuer’s business), it did address the “social” component of ESG, but only in a minimal way by instructing issuers to pro- vide: A description of the registrant’s human capital resources, in- cluding the number of persons employed by the registrant, and any human capital measures or objectives that the reg- istrant focuses on in managing the business (such as, de- pending on the registrant’s business and workforce, measures or objectives that address the development, at- traction and retention of personnel). Modernization of Regulation S-K Items 101, 103, and 105, 85 Fed. Reg. 63,726, 63,760 (Oct. 8, 2020) (codified at 17 C.F.R. pt 229). This brief state- ment was the SEC’s only reference in this release to the goals of diversity and affirmative action. Thus, although Item 101 now at last addresses the social component of ESG, it does so only in a minimal way. Not surprisingly, some observers have reported that more investors are concerned about “the under-disclosure of material information” about human capital, not over- disclosure. See Ho, supra note 42, at 73–75 (emphasis deleted). 45 For a description of a forceful intervention by a group of six large institutional shareholders (including the Big Three) that succeeded in caus- ing both ExxonMobil and Chevron to support climate change reforms that these firms had previously opposed, see Condon, supra note 8, at 25. Not only are broadly diversified institutions seeking more ESG disclosures, they are also acting upon them as well, sometimes by suing portfolio companies. See Alexander I. Platt, Index Fund Enforcement, 53 U.C. DAVIS L. REV. 1453, 1458–59 (2020). In contrast, diversified investors would be wasting their funds to seek to improve or mitigate idiosyncratic risks. For example, if they sought to improve operating performance at Ford, the resulting gains, if any, might only be offset by a stock decline at GM, which would lose market share to Ford. COFFEE 8/20/2021 6:32 PM No. 2:602] THE FUTURE OF DISCLOSURE 619 This activism of diversified institutional investors on ESG issues contrasts sharply with their general passivity on firm- specific business issues, and this disparity can only be ex- plained in one way: diversified institutional investors are deeply concerned about whether the market is accurately in- corporating climate-change-related risks into asset prices.46 Although diversified investors are generally indifferent to id- iosyncratic risks (from which diversification protects them), they have little defense against systematic risk. Climate change probably presents the clearest example of systematic risk. Although it will not affect all companies the same (i.e., the risk is heterogeneous), investors cannot escape it through diversification. That is, there is no obvious class of companies whose stock will go up as the result of global warm- ing so as to compensate diversified investors for those other stocks that go down. Given that they are unavoidably exposed to this risk, di- versified investors rationally want disclosures that enable them to estimate its impact on their portfolios. Further, they may want to take actions (either by voting, litigation, or per- suasion) to induce changes that reduce such risk even if they cause losses to some companies in their portfolio—so long as the action taken implies greater gains than losses to their portfolio. A clear indication of this new activism came in 46 For the view that the market is not doing this and a careful specifi- cation of the reasons why it tends to misprice climate-related and ESG risks, see generally Madison Condon, Market Myopia’s Climate Bubble, UTAH L. REV. (forthcoming 2021) (on file with the Columbia Business Law Review), https://ssrn.com/abstract=3782675. Diversified institutions have less con- cern about whether the market is mispricing information relating to idio- syncratic risk. Not only are these institutions unable to analyze all their portfolio companies in detail, but even if they discovered mispricing of firm- specific information and sought to exploit it, it is not clear that such efforts would benefit them on a portfolio-wide basis. For example, if activists con- vinced an index fund that Ford should be pressured to sell a marginally profitable division (and Ford did so under pressure, thereby increasing its market share and stock price), it does not follow that this effort would nec- essarily benefit the index fund, as the market share gained by Ford might only be lost by General Motors, another portfolio company of the index fund. In short, from the portfolio-wide perspective, this was only a zero-sum trans- fer which required the index fund to incur some transactional costs. COFFEE 8/20/2021 6:32 PM 620 COLUMBIA BUSINESS LAW REVIEW [Vol. 2021 January 2021, when BlackRock’s CEO, Larry Fink, wrote to the CEOs of major public corporations asking them to commit to a “goal of net zero greenhouse gas emissions by 2050.”47 This is a costly change that will adversely impact earnings at many companies, but it seems intended to benefit other firms in BlackRock’s portfolio even more, and thus may result in a net benefit for BlackRock.48 Another example of a systematic risk that has concerned institutional investors and the SEC involves the COVID-19 pandemic. Here, the SEC has been actively seeking increased disclosure, asking all public companies to explain how the pandemic is affecting them.49 Obviously, pandemics represent a form of systematic risk because diversification again cannot protect an institution’s portfolio. Although the examples of climate change and a pandemic are clear, skeptics may respond that not all ESG disclosure relates to systematic risk. For example, ESG disclosures often focus on racial diversity and inclusiveness. Skeptics may doubt that such disclosures relate at all to systematic risk dis- closure. Yet, over the long run, these disclosures arguably re- late to the potential viability of our corporate system. If our corporate system cannot offer inclusiveness and promote di- versity, it may subject itself to a political risk that capitalism (or, at least, contemporary corporate governance) will be 47 See Larry Fink, Letter to CEOs, HARV. L. SCH. F. ON CORP. GOVERN- ANCE (Jan. 30, 2021), https://corpgov.law.harvard.edu/2021/01/30/letter-to- ceos/ [https://perma.cc/8Q6D-8KXY]. This letter went on to describe several metrics that BlackRock would use in evaluating whether their portfolio companies were in compliance and a “heightened-scrutiny model” that its actively-managed funds would use in dealing with non-complying portfolio companies. Id. 48 See id. 49 There has been a continuing stream of SEC statements since March 2020. See Coronavirus (COVID-19)—Disclosure Considerations Regarding Operations, Liquidity, and Capital Resources, U.S. SEC. & EXCH. COMM’N, https://www.sec.gov/corpfin/covid-19-disclosure-considerations [https://perma.cc/CD4M-LZDM] (last modified June 23, 2020). For a brief overview, see Frank Lopez et al., Updating Publicly Traded Company Dis- closures for COVID-19, LAW360 (Mar. 20, 2020, 5:47 PM), https://www.law360.com/articles/1253913/updating-publicly-traded-com- pany-disclosures-for-covid-19 [https://perma.cc/2XW4-6HWA]. COFFEE 8/20/2021 6:32 PM No. 2:602] THE FUTURE OF DISCLOSURE 621 politically challenged and could conceivably yield to a more state-run system of corporate governance. To some degree, such a transition seems to be already occurring in Europe and the United Kingdom.50 Again, diversification could not ade- quately protect investors against this risk of political up- heaval, which could directly threaten the traditional inves- tor’s goal of shareholder wealth maximization. One last point about “systematic risk” needs to be under- scored: for diversified investors, systematic risk overlaps heavily with securities law’s bedrock concept of materiality. Because systematic risks cannot be diversified away by inves- tors, information about such risks is more material to diversi- fied investors than information about “idiosyncratic” risks, both because institutional investors are in theory exposed only to “systematic risk” and because they (and, as a practical matter, only they) may be able to take corrective action to min- imize such risk.51 Indeed, as later discussed, the major 50 Nations can be located on a corporate governance continuum ranging from “shareholder-centric” systems (of which the United States is the lead- ing example) to “stakeholder-centric” systems (into which category most Eu- ropean nations fall). See Katharine V. Jackson, Towards a Stakeholder- Shareholder Theory of Corporate Governance: A Comparative Analysis, 7 HASTINGS BUS L.J. 309, 309–11 (2011). In Europe and the United Kingdom, there has been recent movement towards increasing the rights of, and du- ties owed to, stakeholders. One step in this direction has been the recent popularity of “stewardship codes” for investors. See Jennifer G. Hill, Good Activist/Bad Activist: The Rise of International Stewardship Codes, 41 SE- ATTLE U. L. REV. 497, 497–98 (2018); Jennifer G. Hill, Shifting Contours of Directors’ Fiduciary Duties and Norms in Comparative Corporate Govern- ance, 5 U.C. IRVINE J. INT’L, TRANSNAT’L & COMPAR. L. 163, 175–78 (2020); Jackson, supra, at 387–89. 51 For discussions of the magnitude of climate change as a leading sys- tematic risk and investors’ concerns about it, see INST. FOR SUSTAINABLE LEADERSHIP, UNIV. OF CAMBRIDGE, UNHEDGEABLE RISK: HOW CLIMATE CHANGE SENTIMENT IMPACTS INVESTMENT 5 (2015); Stefano Battison et al., A Climate Stress-Test of the Financial System, 7 NATURE CLIMATE CHANGE 283, 288 (2017). For our purposes, “materiality” is defined for the federal securities laws in remarkably broad language, which was set forth in Basic Inc. v. Levinson, 485 U.S. 224, 231 (1988) (“[A]n omitted fact is material if there is a substantial likelihood that a reasonable shareholder would con- sider it important in deciding how to vote.” (internal quotation marks omit- ted) (quoting TSC Indus., Inc. v. Northway, Inc., 426 U.S. 438, 449 (1976))). COFFEE 8/20/2021 6:32 PM 622 COLUMBIA BUSINESS LAW REVIEW [Vol. 2021 diversified institutions have begun to take direct action on a coordinated basis (through litigation, proxy fights, or the threat of exit).52 Ultimately, the informational needs of the diversified in- stitutional investor depend on the role that it is willing to as- sume. For some time, commentators have presented the diver- sified investor as being “rationally reticent” and willing to act only on issues framed and presented by non-diversified activ- ist investors.53 Understandable as this view was, it no longer conforms with the current reality in which the Big Three (and others) are taking a leadership role in pressing portfolio com- panies for systematic risk-related changes. BlackRock, for ex- ample, showed little “reticence” in insisting that its portfolio companies adopt a “net zero” emissions policy by 2050. Thus, it is necessary to recognize that, within the boundaries set by systematic risk, indexed investors can indeed be activists— even (because of their greater scale) potentially more effective activists than the hedge funds. III. THE RETAIL INVESTOR: THE RELEVANCE OF OPTION PRICING THEORY AND COMMON OWNERSHIP Two different conflicts are arising between institutional and retail shareholders, which have not been recognized or addressed by existing SEC policy. A. Activism and Option Pricing Theory Institutional and individual investors recurrently disagree over an important issue of business policy. Specifically, In short, if reasonable investors generally want the information, it becomes presumptively material. My premise here is only that mega-sized institu- tional investors (such as the Big Three) are objectively reasonable. 52 See infra Section IV.C. 53 See Ronald J. Gilson & Jeffrey N. Gordon, The Agency Cost of Agency Capitalism: Activist Investors and the Revaluation of Governance Rights, 113 COLUM. L. REV. 863, 895–96 (2013) (arguing that “activists”—such as hedge funds—will research and frame issues, which index firms will support without having to expend funds or effort). COFFEE 8/20/2021 6:32 PM No. 2:602] THE FUTURE OF DISCLOSURE 623 institutional investors object to attempts by the corporate is- suer to diversify or to hold a conglomerate-like portfolio of un- related companies in different industries. Both because the in- stitutional investor can easily diversify its own holdings and because it is redundant to diversify on both the investor and corporate levels, diversified investors want to streamline the corporation’s portfolio of investments and sell or spin off divi- sions or subsidiaries that are outside the corporation’s core line of business. From an economic perspective, only synergies between divisions can justify a corporation in holding invest- ments in multiple unrelated companies. Still, many individual investors do not diversify54 and therefore do not share this policy preference. Why do they not diversify? This presents something of a mystery, but many investors may lack ade- quate resources or may prefer higher risk, or their failure may be the product of simple ignorance. As a result, such undiver- sified individual investors logically benefit from corporate di- versification, as it reduces the risk of the investments they hold. Today, activist hedge funds regularly “engage” target cor- porations, buying a five percent or slightly greater stake and then seeking to pressure the target into reducing its degree of diversification (and simultaneously increasing leverage, often through stock buybacks).55 Generally, these campaigns pro- duce an immediate positive stock market reaction when the activist hedge fund crosses the five percent ownership thresh- old and files the mandatory Schedule 13D (which typically an- nounces both its ownership position and its proposed plans to reduce diversification and increase leverage).56 Although this 54 See Brad M. Barber & Terrance Odean, The Behavior of Individual Investors, in 2B HANDBOOK OF THE ECONOMICS OF FINANCE 1533, 1560–62 (George M. Constantinides et al. eds., 2013). 55 For a detailed discussion of this pattern, see generally John C. Cof- fee, Jr. & Darius Palia, The Wolf at the Door: The Impact of Hedge Fund Activism on Corporate Governance, 41 J. CORP. L. 545 (2016). 56 Although an intense debate continues over the long-term impact of hedge fund activism, a consensus exists that the filing with the SEC (usu- ally on Schedule 13D) of a disclosure announcing that the activist has taken a five percent (or greater) position in the stock of a publicly held company is associated with a positive abnormal stock return. See Alon Brav et al., COFFEE 8/20/2021 6:32 PM 624 COLUMBIA BUSINESS LAW REVIEW [Vol. 2021 stock price reaction suggests that shareholders as a group are made better off by these campaigns, undiversified investors may still be made worse off. As “buy and hold” investors,57 in- dividual retail investors are unlikely to sell and probably will continue to hold stocks that are now subject to higher risk at the corporate level because of reduced diversification. Does the increase in expected return justify this increased risk? No simple conclusion is warranted here.58 Because the CAPM assumes that the market price of a widely traded stock is determined by the interaction of large, fully diversified institutional investors,59 the small retail in- vestor will not have much impact on the stock price (even if some such investors do sell). Because the stock price is thus unlikely to decline (as institutional investors are happy with this new trade-off of risk and return), these individual inves- tors need disclosure that makes clear to them that they may now be subject to greater risk. Arguably, if the SEC continues its traditional policy of protecting retail investors, the SEC should mandate disclosures that warn these investors of this increased risk. Effectively, the SEC should use this oppor- tunity to prod investors toward greater diversification. Hedge Fund Activism, Corporate Governance, and Firm Performance, 63 J. FIN. 1729, 1736–37, 1756–60 (2008). Beyond that point, empirical conclu- sions are contested. 57 Retail investors tend to be “buy and hold” investors (who do not trade actively), John C. Coffee, Jr., Reforming the Securities Class Action: An Es- say on Deterrence and Its Implementation, 106 COLUM. L. REV. 1534, 1559 (2006), probably because they face higher trading costs than institutional investors who, because they trade in volume, receive quantity discounts. 58 The taste for risk is subjective and individuals differ. Thus, although a hypothetical five percent stock market gain might induce some (or even most) investors to accept the increased risk associated with increased lever- age or reduced diversification, it may not please all shareholders. Also, the increased risk may not be evident to many retail shareholders (who see only the increased stock price). This conclusion will be regarded as heresy by neoclassical economists who assume that all shareholders favor policies that increase the share price. See, e.g., FRANK H. EASTERBROOK & DANIEL R. FISCHEL, THE ECONOMIC STRUCTURE OF CORPORATE LAW 69–71 (1991). This, however, ignores that rational investors will focus on the risk-return ratio and vary in their reactions. 59 See supra Part II. COFFEE 8/20/2021 6:32 PM No. 2:602] THE FUTURE OF DISCLOSURE 625 Nothing in existing disclosure rules provides for anything re- sembling such disclosure or such advice. This point about the increased risk associated with hedge fund activism needs to be generalized. The famous (and Nobel Prize-winning) work of Fischer Black and Myron Scholes on option pricing theory begins from their insight that, once a public company takes on significant debt, its common stock can be modeled (and is best understood) as an option on the corporation’s assets.60 That is, the common stockholders col- lectively hold an option, which, on the maturity of the debt, allows them either to let the corporation default on its debt (which is the equivalent of letting their option expire) or to pay the debt off (which is the equivalent of exercising their option). In this view, the “real” owners of the corporation are its debt holders, who have no choice (because the shareholders have limited liability and cannot be held personally liable if the firm defaults on its debt). Unlike the debtholders, the stockholders do have the choice of (1) allowing the company to default (and thus turning the company over to the creditors) or (2) paying off the debt (and in effect exercising the option). Presumably, they will make the choice that maximizes their own interests (possibly at the expense of creditors and other stakeholders). The immediate relevance of this point involves the incen- tive effects on the option holders (i.e., the common sharehold- ers). As option holders, they can be expected to act rationally so as to maximize the value of their option. What does that imply? Under the Black/Scholes model, the most important factor in determining the value of an option is the variance in the value of the underlying asset (here, the corporation’s as- sets).61 In short, the greater the variance in expected corpo- rate returns, the greater the value of the option. This may seem counter-intuitive, because greater variance in expected returns is unattractive to debtholders and reduces the value 60 Fischer Black & Myron Scholes, The Pricing of Options and Corpo- rate Liabilities, 81 J. POL. ECON. 637, 649–50 (1973). For an accessible ex- planation of option pricing, see RONALD J. GILSON & BERNARD S. BLACK, (SOME OF) THE ESSENTIALS OF FINANCE AND INVESTMENT 245–57 (1993). 61 See Black & Scholes, supra note 60, at 650–52. COFFEE 8/20/2021 6:32 PM 626 COLUMBIA BUSINESS LAW REVIEW [Vol. 2021 of the corporation’s assets in their hands. Still, a critical in- sight of the option pricing model is that the common stock- holders, as the holders of an option, can increase the value of their option by increasing the variance associated with the corporation’s assets and investments. More bluntly, this means that by increasing the riskiness of the corporation’s in- vestments, they benefit themselves (as the option holders) at the expense of the corporation’s creditors and other stakehold- ers. Thus, we now have a scenario for opportunism by the shareholders: if they take on riskier investments or leverage up the company, they gain and the creditors lose. Of course, creditors can resist by insisting on protective covenants in loan agreements and bond indentures, but these are in declin- ing use.62 Even if creditors could negotiate contractual protec- tions against increased leverage, it is much harder to prevent their corporate borrower from otherwise taking on riskier in- vestments or making higher-risk bets. Such restrictions would be hard to draft and would be resisted intensely by corporate managers because these restrictions would tie their hands, denying them needed flexibility over an extended period. From the standpoint of the Black/Scholes model, the be- havior of activist hedge funds in seeking to reduce corporate diversification and increase leverage (or otherwise withdraw funds from the firm) makes perfect sense. The hedge funds are essentially seeking to increase risk to benefit the majority of shareholders at the expense of creditors and other stakehold- ers. Although the hedge funds are not themselves diversified, they know that they will be rewarded by an immediate share price increase if they propose an action (such as increasing leverage or reducing diversification) that will benefit the di- versified shareholders that they are serving. 62 Debt covenants became disfavored in the 1980s, and empirical sur- veys found that large public corporations had successfully avoided them. See Morey W. McDaniel, Bondholders and Corporate Governance, 41 BUS. LAW. 413, 426 (1986); William W. Bratton, Jr., Corporate Debt Relationships: Le- gal Theory in a Time of Restructuring, 1989 DUKE L.J. 92, 140–42. COFFEE 8/20/2021 6:32 PM No. 2:602] THE FUTURE OF DISCLOSURE 627 Although there has been a voluminous and heated debate over the practices and ethics of activist hedge funds,63 this de- bate has usually been framed in terms of whether hedge funds have a “short-term” perspective that contrasts with the alleg- edly “long-term” perspective of the target corporation’s man- agers. This misses the larger point. Without denying that there could be differences in the time frames favored by activ- ist shareholders and managers,64 it is simpler (and theoreti- cally more elegant) to focus instead on the enhanced value to the option held by the shareholders as the result of accepting increased risk. Possibly, some will respond: If this desire to increase the risk level is so obvious, why didn’t the target management do this themselves and profit from accepting increased risk and lesser diversification? Why have only activist hedge funds pro- posed this? Here, there is a simple answer: corporate manag- ers have firm-specific human capital invested in the firm, which they cannot easily hedge. Put more simply, sharehold- ers hold multiple stocks, but managers have only one job. Managers will rationally resist the risk of increased leverage or diminished diversification because it exposes them to po- tential bankruptcy and the loss of their human capital. Thus, shareholders make superior risk bearers. Today, activist hedge funds have learned that if they pro- pose a specific scenario for increasing risk (such as by 63 For representative positions, see generally Lucian A. Bebchuk, Alon Brav & Wei Jiang, The Long-Term Effects of Hedge Fund Activism, 115 COLUM. L. REV. 1085 (2015); Coffee & Palia, supra note 55; Leo E. Strine, Jr., Who Bleeds When the Wolves Bite?: A Flesh-and-Blood Perspective on Hedge Fund Activism and Our Strange Corporate Governance System, 126 YALE L.J. 1870 (2017). 64 Standard compensation formulas in the hedge fund industry (which typically annually award hedge fund managers twenty percent or more of the fund’s gains) do give hedge fund managers considerable reason to focus on the short run. See Michal Barzuza & Eric Talley, Long-Term Bias, 2020 COLUM. BUS. L. REV. 104, 133–34. Moreover, hedge fund managers are aware that their investor clients can easily move funds to another hedge fund if they do not deliver immediate gains. In contrast, corporate managers are conventionally assumed to have a longer term (and more risk-averse) perspective because of their locked-in human capital. COFFEE 8/20/2021 6:32 PM 628 COLUMBIA BUSINESS LAW REVIEW [Vol. 2021 following a riskier investment policy, selling off corporate as- sets that mainly provide unneeded diversification, or increas- ing leverage, buybacks, and dividends), they will find it easy to sell this policy to institutional shareholders. This motiva- tion to increase risk and reduce diversification did not begin with activist hedge funds. “Bust-up” takeover bidders did the same thing in the late 1980s.65 But these bidders were chilled by the poison pill, state takeover laws, and judicial develop- ments.66 The evidence is clear that activist hedge funds can today compel target managements to negotiate their demands and place the hedge fund’s agents on the target’s board.67 More importantly, the activist fund spends far less, fares far better, and achieves results far more quickly than the tradi- tional hostile bidder.68 As a result, the activist hedge fund has largely replaced the hostile bidder, but the implications for the undiversified retail investor remain the same: increased risk is generally contrary to their preferences. Although the clear winners here are diversified sharehold- ers and activist funds, the clear losers are not only creditors, managers and stakeholders. In addition, the undiversified re- tail investor is a bystander whose fate is less easily summed up. This shareholder may sometimes win and sometimes lose, depending upon how much risk the shareholder is willing to 65 For a contemporary discussion of these takeovers, see generally John C. Coffee, Jr., Shareholders Versus Managers: The Strain in the Corporate Web, 85 MICH. L. REV. 1 (1986). 66 During the 1980s, the Delaware Supreme Court upheld the validity of the poison pill in Moran v. Household International, Inc., 500 A.2d 1346 (Del. 1985), and after Paramount Communications, Inc. v. Time Inc., 571 A.2d 1140 (Del. 1990) it seemed (at least for a time) that the “just say no defense” would be upheld in Delaware. Possibly as a consequence, hostile takeovers declined following 1990, and other techniques (including hedge fund engagement) grew. See Coffee & Palia, supra note 55, at 553, 554 & n.24, 555–57 (tracing the rise of hedge fund activism). 67 For a fuller discussion of the tactics and success of hedge fund cam- paigns, see John C. Coffee, Jr., Robert J. Jackson, Jr., Joshua R. Mitts & Robert E. Bishop, Activist Directors and Agency Costs: What Happens When an Activist Director Goes on the Board?, 104 CORNELL L. REV. 381, 395–408 (2019). 68 See id. (noting that the costs of activist campaigns “are growing” but also that activists can extract private benefits from target firms). COFFEE 8/20/2021 6:32 PM No. 2:602] THE FUTURE OF DISCLOSURE 629 accept. The bottom line then is that retail shareholders are affected much more than they realize, and they may bear more risk than they understand or want. How (if at all) should the SEC protect these investors? The long-term answer may be that retail investors should be prod- ded (or at least encouraged) by the SEC to diversify. But the SEC’s ability at investor education is open to doubt.69 The public does not respond well to the government’s paternalistic advice. To the extent that investor education falls short (as I expect it will), the second-best policy may be to require greater disclosure that alerts the individual investor to the risk and dangers associated with hedge fund campaigns, reduced di- versification, and increased leverage. This policy, of course, can only be pursued on a case-by-case basis, but the end goal should be to encourage greater diversification by retail inves- tors. B. Common Ownership and the Undiversified Retail Investor As noted earlier, BlackRock has announced that it will push all its portfolio companies to comply with a “net zero” emissions goal by 2050.70 For companies engaged with fossil fuels (oil, gas, or coal), this will be a considerable challenge that could imply a period of continuing losses (or at least greatly reduced earnings). Nor will BlackRock’s challenge be the only one that many companies receive with respect to cli- mate change. Other asset managers may assert challenges on social or governance issues (including diversity). Because in- dexed investors must remain invested in these indexes (as they promised their investors that they would conform to them), there is little possibility that these investors will “exit” 69 Unquestionably, retail investors need investor education, but it is highly questionable that the SEC can teach this course successfully. Part of the problem is that for every dollar spent by the SEC toward this end, far more will be spent by mutual funds, investment advisers, and the advocates of crowdfunding, all predicting that they can find you the next Microsoft or Apple. More likely candidates to teach the value of diversification are the private proponents of diversification, such as, most notably, Vanguard. 70 See supra note 47 and accompanying text. COFFEE 8/20/2021 6:32 PM 630 COLUMBIA BUSINESS LAW REVIEW [Vol. 2021 and disinvest if disappointed with the portfolio company’s re- sponse. By definition, indexed investors are there to stay, alt- hough increasingly they may have a hostile relationship with management. Ideally, these policies will prove profitable for the asset managers who are asserting them, but there is every reason to believe that undiversified retail investors will be caught be- tween the rock and the hard place. To such investors, BlackRock’s challenge is essentially a threat. Although politi- cal and even legal challenges to BlackRock’s strategy are pos- sible, the immediate need is for disclosure that explains the impact of its policy to retail investors. How much will it cost shareholders to reduce the company’s emissions level to zero? What actions might a BlackRock or other asset manager take to enforce its position or discipline deviant firms?71 The SEC does not yet seem to have thought through the kinds of disclosures that are necessary or desirable from both sides once such an adversarial relationship develops. IV. THE SPECIAL CASE OF ESG DISCLOSURES: CAN FIDUCIARIES LAWFULLY USE THIS INFORMATION? Although the term “ESG” is of fairly recent vintage, the concept has been around for forty years or longer.72 Still, a paradox remains: Even if investors want ESG information, can their fiduciaries, acting for them, make decisions based on such criteria with regard to either investing or voting? The problem is that some fiduciaries are legally barred from rely- ing on ethical considerations, except under special circum- stances. Conservatives have long argued that fiduciaries (and particularly trustees subject to ERISA or common-law stand- ards) are not permitted to rely on ethical or moral judgments (or socially desirable goals) unless they can conclude, based on 71 Here it should be recognized that even passive asset managers, such as BlackRock, also run actively managed firms that could exit from a non- complying portfolio firm, thereby driving down its stock price even further. 72 For a good history of the rise of ESG investing, see Schanzenbach & Sitkoff, supra note 14, at 395–99. COFFEE 8/20/2021 6:32 PM No. 2:602] THE FUTURE OF DISCLOSURE 631 clear evidence, that pursuit of such goals will work to the fi- nancial advantage of their beneficiaries.73 From this perspec- tive, ESG data can be considered by fiduciaries only if they can reasonably find that it satisfies a risk-return test that en- ables them to improve their portfolio’s overall risk-adjusted return.74 But this is a more complex exercise than it initially appears. This Part will argue that the SEC can play a useful role in resolving this dilemma. A. A Brief History of ESG The idea that investors should consider the social behavior and impact of the companies in which they invest has a long history, and some trace it back as far as the sermons of John Wesley, the founder of the Methodist Church, who advised his followers that they could not ethically invest in companies that profited from the slave trade.75 Similarly, some mutual funds have long employed a social screen to winnow out those companies that make anti-social products. The first such U.S. fund, Pioneer Investments, dates to 1928 and remains in busi- ness today, continually stressing its commitment to Christian values.76 The broader concept of socially responsible investing (or “SRI”) flowered in the 1980s, when the issue of South Afri- can apartheid provoked a crisis and caused ethical investors to seek to disinvest from companies that were active in South Africa.77 Such ethical investing was always in tension with trust fi- duciary law, which requires a trustee to consider only the 73 This debate can be easily traced back to the 1980s, when the key issue involved divestment campaigns aimed at South Africa’s apartheid pol- icies. For the conservative view that social investing was illegitimate, see generally John H. Langbein & Richard A. Posner, Social Investing and the Law of Trusts, 79 MICH. L. REV. 72 (1980). Professors Schanzenbach and Sitkoff appear to be following in this tradition (with some modifications). See Schanzenbach & Sitkoff, supra note 14, at 448–53. 74 This is essentially the position of Professors Schanzenbach and Sitkoff. See Schanzenbach & Sitkoff, supra note 14, at 453. 75 Id. at 392. 76 Id. at 392–93. 77 Id. at 393–95. COFFEE 8/20/2021 6:32 PM 632 COLUMBIA BUSINESS LAW REVIEW [Vol. 2021 interests of the beneficiary.78 This “sole interest” rule is in- tended to protect beneficiaries from fiduciaries who might subordinate the beneficiaries’ financial interests to those of political or social groups with whom the fiduciary sympa- thizes. Legally, the “sole interest” rule implied that the trus- tee had to prefer investments with superior risk-adjusted re- turns regardless of the social impact of the investment. Nervous that they might run afoul of the law, many risk- averse fiduciaries shied away from SRI investing.79 To bring SRI investing into the mainstream, something had to be done, and clever lawyers predictably devised an an- swer. Conceptually, they “rebranded” SRI investing and con- verted it into ESG investing by asserting that consideration of the “governance factors” associated with public corporations would enable the fiduciary to identify superior investments and enhance risk-adjusted return.80 By adding governance to 78 Under what is known as the “sole interest” rule, a trustee must “ad- minister the trust solely in the interest of the beneficiaries.” RESTATEMENT (THIRD) OF TRS. § 78(1) (AM. L. INST. 2007). Under a comment to this section, the Restatement adds that “the trustee has a duty to the beneficiaries not to be influenced by the interests of any third person or by motives other than the accomplishment of the purposes of the trust.” Id. § 78(1) cmt. f; see also UNIF. TR. CODE § 802(a) (UNIF. L. COMM’N 2003). If the trustee acts based on mixed motives, “an irrebuttable presumption of wrongdoing” arises. Daniel Fischel & John H. Langbein, ERISA’s Fundamental Contradiction: The Ex- clusive Benefit Rule, 55 U. CHI. L. REV. 1105, 1114–15 (1988). However, a plaintiff will still have to prove damages, which can be a considerable hur- dle. 79 One recent study surveying 310 fiduciaries found that forty-seven percent believed that the use of ESG criteria either conflicted or might con- flict with their fiduciary duty. See FI360, ESG SURVEY FOR FI360 DESIGNEES 2 (2019). For other recent studies, see Schanzenbach & Sitkoff, supra note 14, at 385 n.7. 80 I borrow the term “rebranding” from Schanzenbach and& Sitkoff, su- pra note 14, at 388. A key moment in this semantic transition from SRI to ESG came in 2005 with the release of a report sponsored by a UN working group and prepared by the international law firm of Freshfields Bruckhaus Deringer, which asserted that ESG investing was not only consistent with the trustee’s fiduciary duties, but was “arguably required in all jurisdic- tions.” UNITED NATIONS ENV’T PROGRAMME FIN. INITIATIVE, A LEGAL FRAME- WORK FOR THE INTEGRATION OF ENVIRONMENTAL, SOCIAL AND GOVERNANCE COFFEE 8/20/2021 6:32 PM No. 2:602] THE FUTURE OF DISCLOSURE 633 the mix, they argued, one not only did good (ethically), but one also did better (financially).81 This in turn enabled law firms to opine to their clients that ESG investing was fully compat- ible with the trustee’s fiduciary obligations.82 A few went even further and suggested that consideration of ESG factors might be mandatory.83 Necessity is often the mother of invention, and the modest claim here advanced is merely that the need to calm the fears of risk-averse trustees best explains the addition of “govern- ance” factors to environmental and social ones in order to con- vert SRI into ESG. Whatever the motive, this rebranding seems to have worked and has rapidly brought ESG into the investment mainstream. As of late 2019, some 1,900 asset managers (including some of the world’s largest) have signed the Principles of Responsible Investment (PRI) endorsing ESG investing;84 hundreds of ESG indexes have been pub- lished that provide ESG ratings on individual companies;85 and Delaware and Oregon have amended their trust law to ISSUES INTO INSTITUTIONAL INVESTMENT 13 (2005); see also Schanzenbach & Sitkoff, supra note 14, at 389. 81 An influential study in 2003 by Paul Gompers, Joy Ishii, and Andrew Metrick gave considerable credibility to the claim that governance factors did influence firm performance. Paul Gompers, Joy Ishiii & Andrew Met- rick, Corporate Governance and Equity Prices, 118 Q.J. ECON. 107, 114–29 (2003); see also Lucian Bebchuk, Alma Cohen & Allen Ferrell, What Matters in Corporate Governance?, 22 REV. FIN. STUD. 783, 785 (2009) (constructing an “entrenchment index” and finding that increases in this index of six gov- ernance features were associated with significant reductions in firm value). The debate over indexes has continued and been robust, but both sides be- lieve governance matters. 82 The Freshfields opinion noted earlier is one example. UNITED NA- TIONS ENV’T PROGRAMME FIN. INITIATIVE, supra note 80, at 13. 83 See id.; Susan N. Gary, Best Interests in the Long Term: Fiduciary Duties and ESG Integration, 90 U. COLO. L. REV. 731, 734–36 (2019). 84 Schanzenbach & Sitkoff, supra note 14, at 387 (citing Signatory Di- rectory, PRINCIPLES FOR RESPONSIBLE INV., [https://perma.cc/R66R-72LU] (last visited Dec. 22, 2019) (click “View/Download File”)). Of these 1,900, the majority were European asset managers, showing the greater acceptance of ESG investing in Europe. See id. at 387 n.15. 85 Id. at 387. COFFEE 8/20/2021 6:32 PM 634 COLUMBIA BUSINESS LAW REVIEW [Vol. 2021 specifically address and facilitate ESG investing.86 Even the major index funds, including BlackRock and Vanguard, which ordinarily ignore firm-specific factors as “indexed investors,” are now actively focused on some ESG issues (such as climate change) and seeking to impose changes on firms in their port- folio.87 B. The Remaining Legal Uncertainty Still, problems persist. Although the law in Europe has been sufficiently revised and clarified to make ESG investing appear safe for even the most risk-averse trustee,88 U.S. fidu- ciary law in most states still imposes a “sole interest” rule that instructs the fiduciary to consider only the interests of the beneficiary (and thus not to give weight to the interest of oth- ers, including, the billions who may be affected by adverse cli- mate change).89 Of course, the “rebranding” of ESG some fif- teen years ago was designed to show that ESG, as revised, could improve risk-adjusted returns, thus satisfying a hard- nosed economic test even without giving weight to collateral benefits to others. Some scholars buy this argument and 86 In 2018, Delaware amended its trust law to authorize ESG investing if it is authorized in the trust instrument. See DEL. CODE ANN. tit. 12, § 3303(a)(4) (2021); see also OR. REV. STAT. §§ 130.020(2), 130.755(3)(i) (2021). 87 See Schanzenbach & Sitkoff, supra note 14, at 387–88. For example, BlackRock’s Larry Fink’s letter to corporate CEOs asking for “net zero” emissions by 2050 is an example of a strong intervention by a diversified investor. See Fink, supra note 47. 88 European regulators have generally accepted and encouraged ESG investing. See Press Release, Eur. Ins. & Occupational Pensions Auth., EI- OPA Issues Opinions on Governance and Risk Management of Pension Funds (July 10, 2019), https://www.eiopa.europa.eu/content/eiopa-issues- opinions-governance-and-risk-management-pension-funds_en [https://perma.cc/M3YG-TFT3] (urging national regulatory authorities within the EU to “encourage pension funds to consider the impact of their long-term investment decisions and activities on ESG factors”); see also Schanzenbach & Sitkoff, supra note 14, at 387. 89 The “sole interest” rule applies to fiduciaries under private trusts, at ERISA plans, and at charitable foundations, but does not normally apply to the directors or officers of mutual funds or hedge funds (unless they are serving as advisors to an ERISA plan). See Schanzenbach & Sitkoff, supra note 14, at 400–01. COFFEE 8/20/2021 6:32 PM No. 2:602] THE FUTURE OF DISCLOSURE 635 consider ESG to no longer be controversial,90 but others con- tinue to have doubts. Most notably, Professors Max M. Schan- zenbach and Robert H. Sitkoff have drawn a sharp distinction between (1) ESG investing based on moral or ethical reasons or to achieve various collateral benefits (such as, I suppose, saving the Earth), and (2) ESG investing intended to improve risk-adjusted returns.91 This distinction between (in their words) “collateral bene- fit” ESG investing and “risk-return” ESG investing92 seem- ingly makes everything depend on the fiduciary’s motive. Re- alists will, of course, recognize that, once risk-averse fiduciaries are properly advised as to the law, they likely will express the legally proper motive and deny the legally im- proper motive. (Hey folks, isn’t that what lawyers are for?) Thus, under this approach, the practical risk of fiduciary lia- bility seems relatively small. Still, the test proposed by Schanzenbach and Sitkoff would actually require considerably more than just a proper motive. They would require the prudent trustee to conclude, before in- vesting based on any special ESG factor, that the “capital mar- kets consistently misprice the factor in a predictable manner that can be exploited net of any trading and diversification costs.”93 Although this test purports to permit ESG investing, it may well be a wolf in sheep’s clothing. Its very demanding standard about mispricing may be much harder for ERISA fi- duciaries to satisfy. In effect, the fiduciary must determine, first, that ESG factors relate to firm performance in the case of a specific company and, second, that this factor has been 90 See Gary, supra note 83, at 799–800. Professor Gary served as the Reporter for the Uniform Prudent Management of Institutional Funds Act, which alone makes her a significant voice in this field. The Principles for Responsible Investment represents probably the leading statement of the necessity for fiduciaries to adopt ESG factors into their investment analysis. It has obtained over 1,900 asset manager endorsements of its statement of principles. See supra note 84. 91 See Schanzenbach & Sitkoff, supra note 14, at 385–86. 92 For their use of this terminology, see id. at 389. 93 Id. at 451. COFFEE 8/20/2021 6:32 PM 636 COLUMBIA BUSINESS LAW REVIEW [Vol. 2021 sufficiently mispriced so that the fiduciary can exploit this mispricing (net of trading and diversification costs).94 Although I agree with them that ESG investing is not man- datory and that prudent trustees can reasonably conclude that they cannot outperform the market (as the Supreme Court has also observed in a relevant recent decision),95 the possibility still seems remote that any court, either state or federal, would second guess and hold liable trustees who do decide to engage in ESG investing in the belief that it will en- able them to achieve a superior portfolio. Courts are not sus- picious of professional trustees, and, absent a personal self- interest on the part of the fiduciary, they have little reason to apply any enhanced scrutiny standard. Nor is there any clear history of courts intervening in this private world to impose liability. In fairness, the “sole interest” rule regulates only some in- stitutional investors (principally ERISA plans, common-law trusts, and charitable foundations) and does not apply to mu- tual funds or hedge funds, which are subject to SEC regula- tion. Still, pension funds account for nearly half of the assets held by institutional investors,96 and asset managers, includ- ing BlackRock, advise them. Thus, the “sole interest” rule (and particularly a Department of Labor rule extending it)97 may reduce the size of the coalitions that can form to take collective action on ESG issues. C. The Impact of a Portfolio-Wide Perspective What is the best way out of this quandary? Here, we need to recognize that the key development is the new high level of 94 Id. at 390–91, 450–53. 95 See Fifth Third Bancorp v. Dudenhoeffer, 573 U.S. 409, 426–27 (2014). 96 In 2018, U.S. pension funds held about $22.7 trillion in assets, ap- proximately forty-one percent of all assets held by U.S. investment funds, pension funds, and insurance companies. See ORG. FOR ECON. COOP. & DEV., OECD INSTITUTIONAL INVESTOR STATISTICS 173 tbl.1 (2020) (on file with the Columbia Business Law Review), https://read.oecd-ilibrary.org/finance- and-investment/oecd-institutional-investors-statistics-2020_9a827fb7-en. 97 See infra Section IV.D. COFFEE 8/20/2021 6:32 PM No. 2:602] THE FUTURE OF DISCLOSURE 637 common ownership that enables diversified institutional in- vestors to take collective action on a portfolio-wide basis. Pro- fessors Schanzenbach and Sitkoff do not discuss this possibil- ity, but fiduciaries should be able to engage in ESG investing on a portfolio-wide basis in full compliance with the “sole in- terest” rule so long as they make a finding that their collective strategy should raise returns or lower risks. For example, sup- pose that ERISA plans were to join both mutual funds and hedge funds in a joint effort to push the major energy compa- nies to adopt tighter standards on emissions and to advance the date on which they become carbon neutral. Their justifi- cation might be that, although this would reduce the financial returns for some portfolio companies (i.e., coal companies), it would benefit other companies (i.e., those who produced solar power, wind power or nuclear power). Such pressure was in fact successfully applied to Royal Dutch Shell and others in 2018.98 Economically, such interventions would make sense— if the losses to the traditional energy companies were out- weighed by gains to the other firms in the portfolio. As Madi- son Condon has framed it: “A rational owner would use his power to internalize externalities so long as its share of the costs to the externality-creating firms are lower than the ben- efits that accrue to the entire portfolio from the elimination of the externality.”99 98 In late 2018, Royal Dutch Shell was pressured by a coalition of insti- tutional investors to set emission reduction targets to reduce its carbon foot- print by twenty percent by 2035 and fifty percent by 2050. See Condon, su- pra note 8, at 2. It had previously opposed these targets and described them as “onerous and cumbersome,” but once approached by this institutional co- alition, it yielded quickly. Id. (internal quotation marks omitted) (quoting Sarah Kent, Shell to Link Carbon Emissions Targets to Executive Pay, WALL ST. J. (Dec. 3, 2018) (on file with the Columbia Business Law Review), https://www.wsj.com/articles/shell-to-link-carbon-emissions-targets-to-ex- ecutives-pay-1543843441). Thereafter, this same coalition next approached ExxonMobil, Chevron, and BP. Id. at 3. 99 Id. at 6. Professor Condon provides us with a well-reasoned hypo- thetical. Assume, she argues, that BlackRock believed it could cause Exxon and Chevron to reduce their carbon emissions by forty percent at the cost of a twenty percent decline in each of their stock prices. Id. at 45. On this as- sumption, she calculates that the stock price decline to BlackRock at these two companies would total $6.3 billion, but that the gain for the rest of their COFFEE 8/20/2021 6:32 PM 638 COLUMBIA BUSINESS LAW REVIEW [Vol. 2021 In the past, even a large institutional investor could not hope to cause a shift in corporate policy at a portfolio firm.100 But in the new age, where the Big Three usually represents twenty-five percent of the shares voted just by themselves101 (and can reach out to their fellow institutions for more sup- port), they seem able to enforce their will effectively. Moreo- ver, the firm managers that they will seek to pressure are typ- ically risk-averse and probably reluctant to jeopardize their careers by engaging in a contested proxy fight with these pow- erful institutions. Of course, fiduciaries at an ERISA plan would have to make an informed judgment and compare the costs and bene- fits from recommended action to their portfolio. But this is ex- actly where consultants will predictably be hired to perform such an analysis.102 Possibly my cynicism is showing, but these consultants will usually be able to justify the requisite findings that their clients want. Indeed, this could become a portfolios would be $9.7 billion, thus producing a substantial net gain. Id. at 45–47. If institutional investors are satisfied with her calculations, they should eagerly pursue such a policy. 100 As Professors Bebchuk and Hirst record, institutional ownership and its concentration have increased rapidly in recent decades. See Bebchuk & Hirst, supra note 8, at 724–27. 101 Id. at 724. 102 For example, an environmental consulting firm, an accounting firm, or a proxy advisor might compare the loss to a major oil company (such as Royal Dutch Shell in our earlier example) from reducing its emissions or carbon footprint by a specified percentage to the benefits to other companies in its portfolio from achieving reduced pollution and postponing adverse cli- mate change. Some asset managers appear to be making these estimates already. Schroders, a major asset manager, has calculated that a four de- gree increase (Centigrade) would produce “global economic losses” of $23 trillion over an eighty-year period. See Condon, supra note 8, at 6 (quoting Schroders Climate Dashboard Points to Four Degree Rise—Despite Increase in Carbon Prices, SCHRODERS (Oct. 19, 2018), https://www.schroders.com/en/au/institutions/insights/investment-in- sights/schroders-climate-dashboard-points-to-four-degree-rise—despite-in- crease-in-carbon-prices/ [https://perma.cc/NE73-78JJ]). Because this is a short Article, it will simply assert (and not demonstrate) that such calcula- tions are difficult and tend to be error-prone. COFFEE 8/20/2021 6:32 PM No. 2:602] THE FUTURE OF DISCLOSURE 639 burgeoning growth business for accounting firms, proxy advi- sory firms, and other consultants. This is also the juncture where the SEC could play a useful role. The SEC could require corporate managers to disclose data that they possess about the costs of change (for example, the costs of reaching carbon neutrality by a given date). Such data (which increasingly exist at many large public compa- nies) could be required to be disclosed in the firm’s Manage- ment Discussion & Analysis (MD&A).103 This would not be an aggressive step for the SEC, as it would only be requiring the disclosure of data in management’s possession and not man- dating any position on ESG investing. Conceivably, one could go even a step further: fiduciaries might also calculate the benefits to their beneficiaries, as in- dividuals, from reducing pollution or slowing climate change.104 Although under ERISA fiduciaries may be legally 103 “Reporting companies,” which include most exchange-listed compa- nies, must comply with SEC Regulation S-K, 17 C.F.R. §§ 229.1–.1406 (2020), by filing certain mandatory periodic disclosures with the SEC. Item 303 of Regulation S-K (“Management’s Discussion and Analysis of Financial Condition and Results of Operations”) requires such a reporting company to “[i]dentify any known trends or any known demands, commitments, events or uncertainties . . . that are reasonably likely” to produce material changes in the issuer’s liquidity, capital resources, or results of operations. Id. § 229.303(b)(1)(i). If there were even “uncertainties” about the costs of reach- ing environmental targets and those costs could have a material impact on liquidity, capital resources, or results of operations, then disclosure would be required. The point here is that the SEC could clarify that such disclosure was required as to major ESG topics, such as climate change, and this would inform and motivate fiduciaries at the major institutional investors. 104 This idea that fiduciaries could serve the best interests of their ben- eficiaries by considering more than simply the impact of their actions on the individual stocks before them will worry some, as it could quickly lead down a slippery slope to very subjective judgments. For example, one could look even beyond the financial interest of the beneficiaries and add into the cal- culation their personal interests as well: reducing pollution may enable the beneficiaries to live longer or better lives. Heretical as this may sound, two distinguished economists have endorsed such a test, arguing that fiduciar- ies should maximize not stock value, but shareholder welfare. See Oliver Hart & Luigi Zingales, Companies Should Maximize Shareholder Welfare Not Market Value, 2 J.L. FIN. & ACCT. 247, 248–50 (2017). By contrast, ERISA’s “sole interest” rule appears to require fiduciaries to focus solely on COFFEE 8/20/2021 6:32 PM 640 COLUMBIA BUSINESS LAW REVIEW [Vol. 2021 required to focus on the financial benefits to their beneficiar- ies, it may be possible to quantify those financial benefits on a portfolio-wide basis. Considering the personal financial ben- efits to investors (i.e., benefits unrelated to the stock price, such as reduced health care costs) would be much more con- troversial, but the Department of Labor’s rule could be modi- fied to permit fiduciaries more discretion and still comply with ERISA’s statutory language. Again, consultants could give fi- duciaries detailed estimates based on legitimate studies. The bottom line here is that trustees who reach a careful, informed position based on legitimate data are unlikely to face any serious risk of liability. What such prudent trustees most need is more information—in particular, information that en- ables them to make comparisons between companies. To illus- trate, suppose the SEC encouraged companies to express in- formation in terms of estimated benchmarks. For example, by what date did the company believe it would become “carbon neutral”? At what cost? Many companies have already re- leased projected dates (2040, 2050, etc.)105 Other companies have remained silent, but if a hypothetical company were to have such an estimated date (which it had never publicly dis- closed), the SEC should make clear that this information is in its view presumptively material (as would be any similar esti- mate of the costs involved in meeting this target date). If such disclosure of internally generated estimates were required in the MD&A,106 this information would also carry very little risk of liability under federal securities laws.107 “financial benefits” (not personal benefits) to the beneficiaries. See Fifth Third Bancorp v. Dudenhoeffer, 573 U.S. 409, 420–21 (2014) (quoting 29 U.S.C. § 1104(a)(1)(A)(i)–(ii) (2014)). Still, outside of ERISA, a broader cal- culation of the benefit that combines financial and personal benefits might be possible. 105 General Motors, for example, expects to be carbon neutral by 2040. See Neal E. Boudette & Coral Davenport, G.M. Phasing out Cars and Trucks Using Gas by 2035, N.Y. TIMES, Jan. 29, 2021, at A1. 106 Again, this is Item 303 of Regulation S-K, 17 C.F.R. § 229.303, which is usually referred to as the “MD&A.” 107 The Securities Exchange Act of 1934 provides in its section 21E (“Application of Safe Harbor for Forward-Looking Statements”) that report- ing companies (with some modest exclusions) do not have liability for COFFEE 8/20/2021 6:32 PM No. 2:602] THE FUTURE OF DISCLOSURE 641 Already, many securities analysts prepare rankings of public companies in terms of ESG criteria. The problem with such rankings is a familiar one: “Garbage In, Garbage Out”— the “GIGO Effect.” Today, ESG disclosure is incomplete and unstandardized, with rankings that are dubious and incon- sistent.108 Public disclosure of ESG data would, at a mini- mum, improve the quality of such rankings and ratings and give trustees greater confidence in relying on such data. The bottom line here is that more ESG data will likely produce more decisions based on ESG criteria—and also greater atten- tion to systematic risk. D. Investment Versus Voting Decisions Proponents of the “sole interest” rule tend to overlook the differences between voting and investment decisions. Histori- cally, they have been viewed differently by both ERISA and the SEC. Although the “sole interest” rule may apply to both, a critical difference is that both the Department of Labor and the SEC have long required fiduciaries to vote the shares held by their funds, on the theory that voting rights are an asset belonging to the fund and should not be wasted.109 Both forward-looking statements that prove false if the statement is “accompa- nied by meaningful cautionary statements” that explain some of the “factors that could cause actual results to differ materially from those in the for- ward-looking statement.” 15 U.S.C. § 78u-5(c) (2019). 108 ESG ratings often disagree, and mutual funds that emphasize their focus on ESG often score below non-ESG funds when subjected to objective review based on their own criteria. See Schanzenbach & Sitkoff, supra note 14, at 431. 109 The position of the Department of Labor (which administers ERISA) dates back to the famous “Avon Letter” of 1988. See Letter from Alan D. Lebowitz, Deputy Assistant Sec’y, U.S. Dep’t of Lab., to Helmuth Fandl, Chairman, Ret. Bd., Avon Prods., 1988 WL 897696 (Feb. 23, 1988). This letter expressed the Labor Department’s view that fiduciaries had to exer- cise their voting powers and vote shares; it was later codified in a 1994 In- terpretive Bulletin issued by the Department of Labor. 29 C.F.R. § 2509.94- 2(3) (2008). This bulletin expressed the view that “[a]ctive monitoring and communication” with corporate management “is consistent with a fiduci- ary’s obligations under ERISA where the responsible fiduciary concludes that there is a reasonable expectation that such [activities] . . . [are] likely to enhance the value of the plan’s investment in the corporation, after COFFEE 8/20/2021 6:32 PM 642 COLUMBIA BUSINESS LAW REVIEW [Vol. 2021 agencies also recognized that voting has low costs (in contrast to investment decisions)110 and that fiduciaries must con- stantly make voting decisions across their portfolios. As a re- sult, both favored a rule of reason with regard to voting and shareholder activism for many years.111 Then, in December 2020, in the concluding days of the Trump Administration, the Department of Labor dropped a bombshell, reversing its prior approach to shareholder activ- ism. No longer endorsing mandatory voting of shares and dropping the prior “reasonable expectation” test, it proposed a rule under which a fiduciary subject to ERISA “must not vote taking into account the costs involved.” Id.; see also Paul Rissman & Diana Kearney, Rise of the Shadow ESG Regulators: Investment Advisers, Sustain- ability Accounting, and Their Effects on Corporate Social Responsibility, 49 ENV’T L. REP. 10155, 10168 (2019). The SEC followed several years later and similarly endorsed the duty of a fiduciary or investment advisor to vote the shares held by a mutual fund or other investment company. See Proxy Voting by Investment Advisers, Investment Advisers Act Release No. 2,106, 2003 WL 215467, at *2 (Jan. 31, 2003). To sum up, both agencies agree that fiduciaries must vote their shares and must do so with the objective of increasing the value of the fund to their beneficiaries. 110 See, e.g., Interpretive Bulletin Relating to the Exercise of Share- holder Rights and Written Statements of Investment Policy, Including Proxy Voting Policies or Guidelines, 81 Fed. Reg. 95,879, 95,881 (Dec. 29, 2016). This revised bulletin adopted a “reasonable expectation” standard for when fiduciaries should engage in shareholder activism, with the expecta- tion being that the plan’s assets would be enhanced. Id. at 95,881, 85,884. However, in December 2020, the Department of Labor withdrew the bulle- tin and adopted a new final rule that significantly changed the standard for voting decisions to require that an ERISA fiduciary believe that voting shares in a particular case would enhance firm value. See infra at notes 111–112 and accompanying text. 111 Even under President Trump, the Department of Labor continued to use a “reasonable expectation” standard until the final days of the Trump Administration. Although it cautioned that the objective of shareholder ac- tivism must be the enhancement of the plan’s value (meaning that the fidu- ciary may not be pursuing political or social preferences), it did not alter significantly prior Department of Labor positions. See Memorandum from John J. Canary, Dir. of Reguls. & Interpretations, Emp. Benefits Sec. Ad- min., U.S. Dep’t of Lab., to Mabel Capolongo, Dir. of Enf’t, U.S. Dep’t of Lab. & Reg’l Dirs. 4–5 (Apr. 23, 2018). However, this position changed dramati- cally in December 2020, as explained in the text and infra note 112. COFFEE 8/20/2021 6:32 PM No. 2:602] THE FUTURE OF DISCLOSURE 643 any proxy unless the fiduciary prudently determines that the matter being voted upon would have an economic impact on the plan.”112 Ultimately, it watered down this position slightly by permitting fiduciaries to use a “principles-based” approach that allowed them to consider the general tendencies of a par- ticular type of vote (i.e., did it generally increase share value, without the need for individualized determination).113 None- theless, this still implied that a prerequisite to voting by an ERISA fiduciary was a prior determination (whether individ- ualized or generalized) by the fiduciary that the vote would have a positive economic impact on the plan; a “no impact” determination still implied that the shares should not be voted.114 This is a rule of enforced passivity, which goes well beyond simply precluding votes based on moral or ethical con- siderations. Consider what this does to ERISA plans that tend to vote affirmatively on ESG measures. Hypothetically, suppose that an ERISA plan would like to vote in favor of a shareholder proposal requiring greater diversity on the board. Assume the plan has no research or other proof that plans benefit gener- ally from such votes. Is it now barred from voting on this 112 See Fiduciary Duties Regarding Proxy Voting and Shareholder Rights, 85 Fed. Reg. 81,658, 81,687 (to be codified at 29 C.F.R. pts. 2509, 2550) (Dec. 16, 2020). This rule became effective on January 15, 2021, just days before the end of President Trump’s term. Id. at 81,695. Before adopt- ing this proposal on shareholder voting under ERISA, the Department of Labor a month earlier adopted a similarly restrictive rule on investments by an ERISA plan under ERISA’s “exclusive benefit” rule. See Financial Factors in Selecting Plan Investments, 85 Fed. Reg. 72,846, 72,848 (Nov. 13, 2020) (codified at 29 C.F.R. pts. 2509, 2550) (instructing fiduciaries that they “may not subordinate return or increase risks to promote non-pecuni- ary objectives”). This provision was somewhat less surprising than the later rule on shareholder voting because investments do involve greater costs and risks. Both may be re-examined by the Biden Administration. 113 See Fiduciary Duties Regarding Proxy Voting and Shareholder Rights, 85 Fed. Reg. at 81,694–95. 114 The Department of Labor eliminated the “must not vote” language from its original proposal, but its final rule is similar in effect: fiduciaries must vote or abstain from voting on the basis of financial benefit to the plan, and the safe harbor for a voting decision requires at least a generalized de- termination as to effect. See id. at 81,663, 81,694–95. COFFEE 8/20/2021 6:32 PM 644 COLUMBIA BUSINESS LAW REVIEW [Vol. 2021 precatory (and largely aspirational) measure? Must it find such evidence or conduct a potentially expensive study first (one whose outcome is not automatically obvious)? Must it show that the market has “mispriced” this special factor?115 Even as revised, the Department of Labor’s new rule does seem to place a costly hurdle before such votes, and it quickly attracted a firestorm of criticism.116 Three basic arguments call into question the legitimacy of this rule. First, voting is different from an investment or sales decision in that (1) loss of diversification benefits is less threatened by voting (whereas such benefits were threatened when investors sold off stocks of South Africa-based compa- nies in the 1980s), (2) the transaction costs of a voting decision are trivial (no brokerage fee is involved and no sale proceeds have to be re-invested), and (3) the failure to vote can also re- sult in loss to shareholders. That is, shareholders may suffer losses as much from the inability to vote as from “bad” voting decisions. Second, an ERISA fiduciary can make a voting decision on a portfolio-wide basis, and the rule should apply differently in these cases to reflect the prospect of gain. Sometimes (as in the case of climate change votes), the fiduciary may be able to net out the gains and losses across its portfolio and find that a positive financial result from the vote is likely. Other times (such as in cases involving race or gender issues), the fiduciary may believe that a market wide shift toward board diversity 115 This is the position taken by Professors Schanzenbach and Sitkoff. See supra notes notes 93–94 and accompanying text. 116 See, e.g., Kurt N. Schacht, The Labor Department Is Tearing Down a Landmark of Investor Protection, BARRON’S, (Sept. 11, 2020, 7:30 AM), https://www.barrons.com/articles/the-labor-department-is-tearing-down-a- landmark-of-investor-protection-51599823800 [https://perma.cc/NJV2- LQQH]; Brian Croce, Proxy Proposal Angers Institutions, PENSIONS & INVS. (Sept. 7, 2020, 12:00 AM) (on file with the Columbia Business Law Review), https://www.pionline.com/regulation/proxy-proposal-angers-institutions; Peter Rasmussen, ERISA Voting Proposal Would Limit ESG Factor Use, BLOOMBERG L. (Sept. 10, 2020, 4:38 PM) (on file with the Columbia Business Law Review), https://news.bloomberglaw.com/bloomberg-law-analy- sis/analysis-erisa-proxy-voting-proposal-would-limit-esg-factor-use. COFFEE 8/20/2021 6:32 PM No. 2:602] THE FUTURE OF DISCLOSURE 645 would yield positive gains, but it would be too costly to conduct the requisite studies.117 Third, some states have amended their “sole interest” rules to recognize and permit ESG investing,118 but the Department of Labor’s rule may now preempt such inconsistent state rules. Traditionally, federal agencies (particularly in Republican ad- ministrations) have been cautious about preempting state law in the belief that, in a federal system, states should be entitled to experiment and respond to local conditions and circum- stances.119 Nonetheless, without explanation or justification, the new Department of Labor rule seems to preempt inconsistent state rules. In response, the Biden Administration moved quickly to announce in March 2021 that it would not enforce the Trump Administration’s rules on ESG investing and ESG voting.120 That is a good start, but more specific guidance needs to be given.121 117 An elaborate literature exists concluding that investments in Cor- porate Social Responsibility” (or “CSR”) do increase firm value modestly and do reduce systematic risk. See, e.g., Rui Albuquerque, Yrjö Koskinen & Chendi Zhang, Corporate Social Responsibility and Firm Risk: Theory and Empirical Evidence, 65 MGMT. SCI. 4451, 4457–63 (2019). 118 See supra note 86 and accompanying text (discussing statutes in Delaware and Oregon). 119 On conservative worries about preemption and the steady increase of preemptive laws, see generally John Kincaid, Foreword, The New Feder- alism Context of the New Judicial Federalism, 26 RUTGERS L.J. 913 (1995). But see Bradley W. Joondeph, The Partisan Dimensions of Federal Preemp- tion in the United States Courts of Appeals, 2011 UTAH L. REV. 223, 225 (finding Republican judges more likely than Democratic judges to favor preemption in difficult cases). 120 On March 10, 2021, the U.S. Department of Labor’s Employee Ben- efits Security Administration issued an enforcement policy statement indi- cating that it would not enforce either the ESG investment rule or the ESG voting rule adopted in the last weeks of the Trump Administration. See Mi- chael Albano, Mary E. Alcock, Alexander Kurtz & Francesca M. Crooks, Cleary Gottlieb Discusses DOL’s Declining To Enforce Rules on ERISA Plan Investments and Proxy Voting, THE CLS BLUE SKY BLOG (Mar. 23, 2021) (summarizing a law firm memorandum). 121 Even if these rules are not enforced by the DOL, they could still have some residual effect, which might lead a court to deem them to preempt arguably inconsistent state law rules. Also, it is conceivable (but COFFEE 8/20/2021 6:32 PM 646 COLUMBIA BUSINESS LAW REVIEW [Vol. 2021 E. The Coming Controversy over Portfolio-Wide Decisionmaking The vision that portfolio-wide voting by institutional inves- tors could reduce externalities has excited scholars.122 Viewed in economic terms, this is a relatively conservative idea be- cause it does not involve fiduciaries subordinating economic returns to social welfare (as the proponents of “stakeholder capitalism” sometimes demand). Rather, fiduciaries are simply seeking to improve returns and reduce risk by respond- ing to systematic risks that could depress the entire economy. Nonetheless, it will likely arouse more controversy than modest concessions to stakeholders. Consider this hypothet- ical: five diversified index funds threaten a proxy contest to replace at least some of the directors of Smoky Coal Corp., un- less it agrees to comply promptly with certain environmental restrictions. Fearing a proxy contest and their ouster, Smoky Coal’s management induces its board to agree to the re- strictions and to appoint a partial slate of directors nominated by the index funds. On the announcement of this decision, Smoky Coal’s stock price falls ten percent, and Smoky Coal’s management closes its principal mine in Kentucky, with a re- sulting large lay-off of miners. Employees are outraged, and a prominent senator from Kentucky schedules a senatorial com- mittee hearing on the “arrogance” of the index funds. Contemporaneously, the state legislature in Kentucky be- gins to draft legislation that would cancel the environmental unlikely) that a private cause of action could be asserted by shareholders or others based on these rules. Affirmative guidance from DOL, not silence, is needed on ESG voting. 122 This idea that common ownership will lead rational investors in a common portfolio to seek to minimize externalities probably originates with Robert G. Hansen and John R. Lott, Jr. See Robert G. Hansen & John R. Lott, Jr., Externalities and Corporate Objectives in a world With Diversified Shareholder/Consumers, 31 J. FIN. & QUANTITATIVE ANALYSIS 43, 46–49 (1996); see also Robert H. Gordon, Do Publicly-Traded Corporations Act in the Public Interest?, ADVANCES IN ECON. ANALYSIS & POL’Y, June 12, 2003, at 1, 6. But these authors wrote before the actual appearance of large-scale common ownership. Recent interest in this topic has likely been provoked by Madison Condon. See Condon, supra note 8. COFFEE 8/20/2021 6:32 PM No. 2:602] THE FUTURE OF DISCLOSURE 647 changes just adopted, and corporate law firms develop a new form of poison pill that would bar the acquisition of more than ten percent of a Kentucky company’s stock by any group of mutual funds that is seeking (or later seeks) to pass or support specified shareholder resolutions. The point here is not that this reaction will succeed, but that counter-pressure is predictable. Although I suspect that the threat of such political retaliation will incline many insti- tutional investors toward no more than reticent participation in attempts to curb externalities through collective action, time will tell. At present, the Big Three have learned to “talk the talk,” but it is still unclear whether they will “walk the walk” (that is, take collective action). Collective action to max- imize portfolio value requires a leader that the index funds can follow (because they are reluctant to initiate contests). In other contexts, activist hedge funds have played this role and the passive giant investors have followed, but in the context of a systematic risk campaign, hedge funds are unlikely to be able to play the same role.123 V. CONCLUSION Briefly and bluntly, this Article has offered five initial con- clusions: (1) Institutional investors logically have a greater in- terest in systematic risk than do undiversified in- vestors (in part because only diversified investors with high common ownership can take effective ac- tion), and much of what ESG disclosures would pro- vide relates primarily to systematic risk. (2) Individual investors (at least if undiversified) have reason to fear that portfolio-wide voting by diversi- fied institutions may adversely affect them. Today, 123 Hedge funds hold too small and undiversified a portfolio to be able to profit from campaigns seeking to curb negative externalities because they do not hold a sufficient volume of securities to incur gains that on a net basis outweigh the losses to the target firm. Basically, only index funds have the scale to profit from such netting. See supra notes 11–13 and accompanying text (discussing the scale of index funds). COFFEE 8/20/2021 6:32 PM 648 COLUMBIA BUSINESS LAW REVIEW [Vol. 2021 they are not adequately advised about the conflicts that arise between their interests and those of both diversified institutional investors and activist hedge funds. (3) Because of the high level of common ownership among diversified institutional investors, these in- vestors can potentially profit on a portfolio-wide ba- sis by taking actions that seek to reduce externali- ties. But again, this aggravates the conflict between diversified and retail investors. (4) Because ESG disclosures and high common owner- ship enable diversified institutions to make deci- sions on a portfolio-wide basis and potentially re- duce systematic risk, the advent of portfolio-wide decisionmaking (both as to investments and voting) may represent the most important contemporary change in institutional investor behavior. Although it appears to be logically consistent with the “sole interest” rule, it will provoke continuing contro- versy. (5) There is little need for a federal “sole interest” rule. No claim has been made that the states have failed to enforce their rules. Absent a showing that state law has failed or cannot be enforced, a federal rule is undesirable, as it may preempt sensible varia- tions at the state level. This Article has not asserted that fiduciaries must favor ESG investing. Decisions to engage or not to engage in ESG investing should both be protected. The real issues for the fu- ture are: (1) whether the Trump Administration’s efforts to chill ESG voting decisions (and thus, by extension, ESG in- vesting) should be reversed; and (2) whether institutional in- vestors are prepared to face significant political controversy and pushback if they pursue portfolio-wide voting policies.124 124 It is not just institutional investors who are under attack, nor simply the Department of Labor that is leading this campaign. In 2020, pos- sibly in response to their activism in assisting institutional investors, proxy advisors were subjected to new and burdensome SEC rules that will slow the process by which they can advise and assist their clients. See generally COFFEE 8/20/2021 6:32 PM No. 2:602] THE FUTURE OF DISCLOSURE 649 For the SEC, this transition may force it to redefine itself. Since its creation, it has been an agency committed to serving “stock-picking” individual investors.125 Such investors are, however, fading from the scene. This does not mean they should be ignored, but that greater attention must be given to the majority of individual shareholders who are now diversi- fied (and often indexed). Common ownership has both an upside and a downside, and to date little scholarly attention has focused on the up- side. Shareholders have not been regarded as the “true own- ers” of the corporation since Berle and Means announced the separation of ownership and control many decades ago.126 Yet today, shareholders have regained the powers of “true own- ers.” Unlike their nineteenth century antecedents (for exam- ple, the railroad, oil and bank barons), the focus of institu- tional investors, as owners, will logically shift to maximizing portfolio value, not the value of individual stocks. One impli- cation of this transition is that it may solve a problem that has frustrated legal scholars for decades. Over that period, many scholars have sought to find a strategy to make public corpo- rations behave more virtuously.127 Despite their gallant ef- forts, they have not fully persuaded most of us, and more con- servative scholars have responded that reducing the Michael Cappucci, The Proxy War Against Proxy Advisors, 16 N.Y.U. J.L. & BUS. 579 (2020) (analyzing the rules). My point here is only that this exam- ple may concern and caution institutional investors, who must realize that activism can produce political retaliation in their cases as well. To be sure, the major institutional investors have much greater financial resources than the proxy advisors. 125 See supra note 3 and accompanying text. 126 ADOLF A. BERLE, JR. & GARDINER C. MEANS, THE MODERN CORPORA- TION AND PRIVATE PROPERTY 120 (Macmillan 1933) (1932). 127 For a partial list, see, for example, generally Cynthia A. Williams, The Securities and Exchange Commission and Corporate Social Transpar- ency, 112 HARV. L. REV. 1197 (1999); KENT GREENFIELD, THE FAILURE OF CORPORATE LAW: FUNDAMENTAL FLAWS AND PROGRESSIVE POSSIBILITIES (2006); LYNN STOUT, THE SHAREHOLDER VALUE MYTH (2012); Einer Elhauge, Sacrificing Corporate Profits in the Public Interest, 80 N.Y.U. L. REV. 733 (2005); William W. Bratton & Michael L. Wachtler, The Case Against Share- holder Empowerment, 158 U. PA. L. REV. 653 (2010). This list is far from exhaustive but includes books and articles that I considered highly original. COFFEE 8/20/2021 6:32 PM 650 COLUMBIA BUSINESS LAW REVIEW [Vol. 2021 externalities associated with corporate behavior is not the job of corporate law.128 Now, without any change in corporate law, at least a possibility has arisen that institutional activism can curb externalities and lead to a better (and not just more prof- itable) society. Ultimately, one final conclusion needs to be stressed: in an era of high common ownership and institutional sensitivity to systematic risk, disclosure gains impact and power that it never had before. In the past, disclosure could trigger govern- mental interventions, private litigation, or reputational in- jury, but today disclosure is becoming self-enforcing, as share- holders can take dispositive action on their own. Yes, this is optimistic, and change may come more slowly. Questions re- main as to how hard diversified funds will push manage- ments, how the high costs of activism can be best shared, and who will organize and lead systematic risk campaigns that are likely to reduce the stock price of the target company.129 These issues should constitute the near term research agenda for le- gal academics. 128 See Henry Hansmann & Reinier Kraakman, The End of History for Corporate Law, 89 GEO. L. J. 439, 439 (2001) (arguing that shareholder wealth maximization is the goal of corporate law); Michael C. Jensen, Value Maximization, Stakeholder Theory, and the Corporate Objective Function, J. APPLIED CORP. FIN., Winter 2010, at 32, 32–33, 35 (arguing that the reg- ulation of externalities falls within the government’s function and is not a task that boards should pursue). 129 Chiefly, these problems surround who can be induced to lead a stra- tegic risk campaign, given that the index funds are likely to remain reticent participants and that activist hedge funds are less likely to profit from such campaigns that reduce the target stock price. I am focusing on these issues in another article.