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US Securities and Exchange Commission

Fund Manager Asks SEC to Write Rule for Disclosure of Revenues From Tobacco

Soyoung Ho  Senior Editor, Accounting and Compliance Alert

· 6 minute read

Soyoung Ho  Senior Editor, Accounting and Compliance Alert

· 6 minute read

The Securities and Exchange Commission (SEC) already has a jam-packed rulemaking agenda planned for this year, altogether about three dozen, including environmental, social, and governance (ESG) matters such as disclosures of climate change, human capital management, and diversity. But a rulemaking petitioner wants the SEC to add one extra to the agenda—tobacco and nicotine sales figures from retailers.

Just as investor groups have argued that effects of climate change are material to financials, petitioner Pella Funds Management, whose motto is “responsible investing,” is casting the disclosures of revenues from the sale of products that contain tobacco as material to investment decisions. And it is making an argument for the disclosures especially because sales of tobacco products have declined due to increased regulations and health risks.

“This creates risk for companies that rely on tobacco-related revenues,” Steven Glass, Pella’s managing director and investment analyst, wrote in a late 2023 rulemaking petition to the SEC. “In response, several of the largest retailers of tobacco products limit discussion about their exposure to tobacco products and make no mention of their revenue from those products. These omissions impact the ability of investors to assess the risk faced by those retailers from the continuing decline in tobacco sales.”

To illustrate his case, Glass points out that CVS Health Corp. stopped selling tobacco products at its pharmacies in 2014. When CVS made the announcement, it estimated that this move would cost about 17 cents per share, which Pella’s calculation equates to 1.6% and 4.5% of fiscal 2023 revenue and earnings per share, respectively.

CVS reported that the absence of tobacco and the estimated associated basket sales reduced same front store sales by about 5.2%, Pella said. The fund management company calculated that tobacco products accounted for less than 3% of that segment’s sales.

“These figures demonstrate that tobacco-related products influence the sale of other products, which in aggregate have a material impact on certain retailers’ results,” Pella’s Glass wrote.

Citing a database by “As You Sow,” (AYS) Pella found 397 mutual funds with $615 billion in assets, with sustainability mandate and the highest two AYS tobacco grade of A or B offered in the US as of September 24, 2023. Many of those funds have a stated objective that avoids investing in tobacco-related businesses.

Pella said that Putnam Sustainable Leaders Fund, which is one of the largest funds in the sample, excludes companies that generate more than 10% of their revenue from tobacco. But as of June 30, 2023, Putnam’s fund was invested in Dollar General, which makes an undisclosed percentage of its sales from cigarettes.

“This is not a criticism of Putnam, which is a highly reputable fund manager and would have researched Dollar General’s tobacco-related revenue,” Glass wrote.

But under today’s reporting regime, Glass said that it’s impossible to substantiate Dollar General’s exposure to tobacco-related revenue.

“This is a considerable concern for the huge number of investors seeking to limit their exposure to tobacco-related products,” he wrote.

The petition includes a non-exhaustive list of companies that are likely to be affected if the SEC were to require disaggregated reporting of revenues to have a specific tobacco line item, in the footnotes, or elsewhere in commission filings—such as BJ’s Wholesale Club Holdings, Inc. Target Corp. and Walmart Inc.

Glass noted that most companies that sell tobacco products make some mention of selling them in their Form 10-K, but some do not mention anything about tobacco even though they sell them. There was one exception. Murphy USA provides the amount of revenue from tobacco.

Thus, without a tobacco-specific revenue reporting, Glass said that it is unable to do the analysis.

“It creates uncertainty whether the absence of disclosing tobacco-related revenue is due to the company not selling those products or choosing not to disclose those sales,” Glass explained. “Another issue is that without the requirement to report tobacco-related revenues, few companies will do so for competitive reasons. A reporting company might be providing its competitors with more information than what they receive in return. Pella was made aware of this issue previously when it requested its investee positions to disclosure their revenue from tobacco-related products. Mandatory reporting will overcome this issue.”

While the petition appears to be making a compelling case for the disclosure, it was also written at a time when interest in ESG investing had started to slightly wane. Some companies, while still pursuing ESG policy, are recasting it as something else other than ESG, such as responsible management, according to recent news reports.

Moreover, a securities lawyer, who did not want to be identified, said this petition will likely not get any traction with the SEC as it is too specific, and it may create a slippery slope to disclosure overload of potentially a revenue break-down of each product sold.

The SEC already heard concerns over its climate change disclosure proposal that includes a 1% financial statement materiality threshold.

Sandra Peters, senior head for global financial reporting policy of the CFA Institute, found the petition interesting.

“I think there is likely already concentration of revenue disclosure requirements in [Financial Accounting Standards Board’s] GAAP and risk disclosure principles in Reg S-K that the SEC would indicate should cover this disclosure if material, rather than the SEC undertaking specific rulemaking,” said Peters, who is a member of the SEC’s Investor Advisory Committee.

However, she did note that the revenue risks are likely only disclosed qualitatively as noted by the petitioner.

“Interestingly, they illustrate that when CVS decided to get out of tobacco the impact was real – but they also demonstrate that CVS made disclosure when they made a decision to exit the business, which may be different from the broader secular trend – the decline in smoking – this investor is trying to assess, quantify, or value,” Peters explained. “At first, I thought this was going to be a values-based anti-tobacco letter, but they are really trying to focus on value relevant information.”


This article originally appeared in the February 6, 2024, edition of Accounting & Compliance Alert, available on Checkpoint.

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