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The Meaning of Materiality in the Context of Climate Change

Maggie Pahl


  • Defines double materiality as the dual analysis of a company's susceptibility to climate risks and its contributions to climate change.
  • Addresses the controversy over whether a company’s impact on climate change is classified as “material.”
  • Looks at how the SEC could avoid challenges to its statutory authority by establishing that climate change is material to the reasonable investor. 
The Meaning of Materiality in the Context of Climate Change
Karl Tapales via Getty Images

What Is Materiality?

The concept of “materiality” arose alongside the inception of securities law itself. Rule 14a-9 of the Securities Exchange Act of 1934 provides that no proxy solicitation shall be made “which . . . is false or misleading with respect to any material fact, or which omits to state any material fact necessary in order to make the statements therein not false or misleading.” In a seminal 1976 decision, the Supreme Court ruled that “an omitted fact is material if there is a substantial likelihood that a reasonable shareholder would consider it important in deciding how to vote.” TSC Industries Inc. v. Northway, Inc. 426 U.S. 438, 449 (1976). In short, the Security Exchange Commission (SEC) has the authority to require companies to disclose information that may sway the investment decision of a reasonable shareholder. The escalating impacts of climate change raise a few questions.

What Is a Reasonable Shareholder?

The leading paradigm invokes the image of a sophisticated passive long-term individual investor. In reality, there is no single reasonable investor. The average investor is not even an individual. Notably, institutional investors own 80 percent of all stock in the S&P 500.

Further, in an economy that rewards diversification of investment, a shareholder is unlikely to consider the performance of a single company in a silo. They are likely to also consider the impact of their proxy vote on their entire investment portfolio. Moreover, widely diversified shareholders, such as institutional investors, may be inclined to consider the impact of a proxy vote on an industry as a whole or even the stability of the economy.

What Is Double Materiality?

The European Union has introduced the concept of “double materiality” in its July 23, 2023, final delegated act of the European Sustainability Reporting Standards (ESRS). In the context of climate change, double materiality is conceptualized as a two-way street. Companies are directed to report on material matters both from an impact perspective (how the company impacts the climate) and a financial perspective (how the climate impacts the company). Therefore, double materiality encompasses the dual analysis of a company's susceptibility to climate risks and its contributions to climate change, including its greenhouse gas emissions.

Has the United States Embraced the Concept of Double Materiality?

To date, the numerous climate-related disclosure proposals presented by the SEC have avoided the application of the term “double materiality.” Allison Herrin Lee, acting chair of the SEC, points out that the Commission was statutorily authorized to regulate “for the protection of investors” and/or “in the public interest.” Lee claims that the SEC’s enabling act empowers it to promulgate statutes requiring companies to disclose information that is “not material” to a reasonable investor.

In making this argument, Lee impliedly concedes that a company’s impact on climate change is not necessarily “material.” Instead of expanding the definition of materiality as the EU did in creating the concept of double materiality, Lee instead is attempting to argue that the SEC has never been limited to requiring disclosures that are deemed material to the reasonable investor. Recent SEC proposals such as the Climate Rule (also known as the Rules to Enhance and Standardize Climate-Related Disclosures for Investors) are efforts to regulate in the public interest as opposed to solely for the protection of investors.

Is the SEC Improperly Expanding its Statutory Authority?

The Climate Rule has been challenged as exceeding the statutory authority of the SEC’s enabling statute. Critics claim that requiring the disclosure of greenhouse gas emissions, for example, benefits environmental activists at the expense of the reasonable investor. SEC Commissioner Hester Pierce issued a dissenting statement rebuking the proposal, stating that “We are not the Securities and Environment Commission.” The argument follows that investors will ultimately be the ones bearing the cost of compliance. Some legal scholars further argue that the federal Clean Air Act delegating climate-disclosure regulation to the Environmental Protection Agency (EPA) likely preempts any statutory authority the SEC might claim. For these reasons, the Climate Rule is likely to be challenged as soon as it is enacted. The outcome of the anticipated regulation will likely resolve the scope of the SEC’s authority, but it will not address the lingering question:

Is Climate Change Material to the Reasonable Investor?

In future securities regulations, the SEC could avoid challenges to its statutory authority by instead establishing that climate change is material to the reasonable investor. Thus, climate-related disclosures are enacted for the protection of investors. Investors, especially institutional investors, are beginning to speak out in support of climate-related disclosures. Their diversified portfolios discussed above encourage big-picture thinking. As the average global temperature of the planet increases and natural disasters become increasingly more common and more destructive, it would simply be unreasonable for an investor to not consider climate change material. Failing to consider how investments impact and are impacted by the climate is risky. A reasonable investor makes informed investment decisions. To facilitate informed decision making, companies must make climate-related disclosures because they are indeed material.