Politics Disguised as Guidance

The Securities and Exchange Commission is busy these days, and on many fronts. Not only has the agency pushed itself into the spotlight with charges of fraud against Goldman Sachs, but SEC Chairman Mary Schapiro recently requested a 12% increase in her budget for next year, a sign that the commission's activities will be further expanding. The role and responsibility of the commission is an important one for investors, particularly if markets fail to self-regulate. But the disparate way that the SEC has handled two big issues--health care costs and global warming--raises questions about whether it's being driven by evidence or swayed by political pressure.

President Obama has spoken in sweeping terms about both health care and global warming. In the run-up to health care reform he did not mince words over his belief in the dire need for corrective action in the U.S. health care system. For example, last June he cautioned that "the cost of our health care is a threat to our economy. It is an escalating burden on our families and businesses. It is a ticking time bomb for the federal budget. And it is unsustainable for the United States of America."

And health care was only one "time bomb" on the horizon, according to President Obama. Using similar rhetoric, he warned immediately after assuming the presidency that climate change "if left unchecked could result in violent conflict, terrible storms, shrinking coastlines and irreversible catastrophe." In fact, as a priority on Obama's domestic agenda, climate change has much in common with health care. According to the president, the threat to the economy each represents is on the same order of magnitude, and he has called repeatedly for prompt, full-scale legislative action on climate change, just as he did for health care.

In February 2010--in the midst of the heated health care debate and teetering negotiations--the SEC announced the issuance of formal guidance to public companies about their disclosure obligations relating to climate change. According to the SEC, this "interpretive release" was intended to clarify long-standing regulations governing disclosures. But it effectively requires public companies to begin including in their annual reports an assessment of any material effects of climate change on their business--both the risks posed by climate change itself and those posed by climate change legislation.

Needlessly micromanaging the disclosure process is always problematic, but interference driven by interest group pressure is doubly problematic.

Despite the comparable economic dangers represented by health care and climate change, the SEC never called for similar disclosure about the risks to companies posed by health care legislation. Yet, after Congress passed sweeping health care legislation in March, reports of the negative financial consequences of the legislation immediately followed. AT&T, Verizon, Caterpillar and Deere & Co. announced anticipated losses ranging from $100 million to $1 billion due to a provision that repealed the tax deductibility for federal subsidies of retiree prescription drug benefits. Johnson & Johnson, Eli Lilly, Baxter International and many others also announced expected performance hits resulting from the new law.

The new statute will also lead to broad, negative effects on the economy that could be sizable. It will boost total U.S. health expenditures by about 0.9% from 2010 to 2019, according to the chief actuary of the Centers for Medicare & Medicaid Services, who also called into question the viability of the legislation's scheduled Medicare payment reductions over the long term and further suggested that the health care system will have difficulty meeting the demands of the newly insured.

Given Obama's treatment of health care and climate change as equivalent dangers to the American economy, and given that massive legislative overhauls are the advocated response, the SEC's decision to step out publicly on climate change and remain silent on health care is puzzling. Actually, it is troubling.

SEC guidance of this type is not a common occurrence. In fact, the commission has not issued guidance relating to disclosures since 1998. Incidentally, that release required companies to address a rather high-profile matter that ultimately was a nonevent, "Y2K."

The Commission's governance of companies' disclosure requirements should ensure that investors have the information they need, in the manner they need, to make sound investment decisions. If existing SEC regulations without additional guidance did not adequately inform companies about how to deal with the risks (and potential gains) from climate change and associated legislation, then certainly those regulations are also insufficient in regard to health care.

So what would prompt the SEC to address one economic and legislative threat and ignore a comparable one? External political pressures are at least part of the explanation. As it turns out, a consortium of environmental groups petitioned the SEC in 2007 and has kept sustained pressure on the commission to oblige public companies to assess and disclose potential financial risk from climate change. It is an indirect way of pushing an agenda that may have otherwise stalled in Washington. In fact, the commission only issued the guidance after a rare party-line vote--more evidence suggesting that the agency was motivated by politics as much as policy.

In short, the commission appears to be biasing the disclosure process by adding new details in one area while ignoring others. Needlessly micromanaging the disclosure process is always problematic, but interference driven by interest group pressure is doubly problematic. A regulatory agency subject to political pressures and the whims of special interest groups is risky business, and not the kind that can be assessed in annual reports.

Alex Brill is a research fellow at AEI.

Photo Credit: iStockphoto/DNY59

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