By Steven Moore
In March of 2022, the Securities and Exchange Commission (SEC) proposed new climate-related disclosure requirements for public companies listed in the United States. This new regulatory scheme would compel public companies to provide certain climate-related financial data and greenhouse gas emission insights in public disclosure filings. While applauded by climate-conscious activists and environmental, social, and governance (ESG) fund managers, many public officials and economic commentators argue that this type of regulation is outside the bounds of the SEC’s statutory authority. More specifically, opponents of this proposal argue that this type of regulation does not fit within the SEC’s mandate to protect investors, maintain fair, orderly, and efficient markets, and facilitate capital in public markets.
The 534-page initial draft includes a rigorous and wide-ranging blueprint for the anticipated reporting requirements, with over 800 specific questions posed to solicit public input. Among other things, the proposal requires companies to disclose:
- Their greenhouse gas emissions footprint, their plans for reducing greenhouse gas emissions, and how they will use carbon offsets to help achieve their emissions goals;
- How their board of directors governs climate-related risks and how their management identifies, assesses, and manages these risks; and
- The climate-related risks they’ve identified, which “have or are likely to have” a material impact on business in the short, medium, or long term, and how those risks affect their business model and strategy.
An unlikely figure among the critics is the SEC’s very own, Commissioner Hester Peirce, who primarily takes issue with proposal’s expansion of the SEC’s materiality standard – Peirce argues that the “action-packed 534 pages” fails to include a rationale for why the SEC’s existing materiality guidance is insufficient. In other words, Peirce and others believe that the SEC is departing from its mandate by focusing its regulatory efforts on matters which are “non-material” to the general investor. The second major dispute arose in comments from policy makers who claim, among other things, that U.S. Supreme Court precedent prohibits federal agencies from adopting such sweeping enforcement measures. Citing the landmark case West Virginia v. Environmental Protection Agency, proponents of this view assert the SEC’s proposal is similarly a “radical or fundamental change to a statutory scheme” which should be left to Congress’ decision making authority.
This article will assess the SEC’s new proposal on two fronts: first, it will determine whether the proposal fits within the SEC’s mandate and its longstanding decision to regulate only matters of material significance. Second, it will analyze the aforementioned claims of regulatory overreach to determine whether the new reporting requirements are within the SEC’s jurisdiction.
The SEC’s Mandate Per the Securities Act of 1934
Following the stock market crash of 1929, public trust in U.S. markets and the government’s ability to regulate them effectively was at an all-time low. In an attempt to regain control of markets and bolster investor sentiment, Congress held a number of policy hearings to get a better understanding of what went wrong. These hearings led to the passing of the Securities Act of 1933 and, subsequently, the Securities Exchange Act of 1934, which created the SEC.
Congress issued the U. S. Securities and Exchange Commission a three-part mandate: (1) protect investors; (2) maintain fair, orderly, and efficient markets; and (3) facilitate capital formation. Over the years, Congress has continued its efforts to make the market a safer place for individual investors by empowering the SEC to achieve the goals of its mandate. Despite the SEC serving as a protective shield for investors, there are fears that both its power and love of tighter regulations will eventually harm the market. As we enter a new era of technological innovation and uncover new challenges to market stability, the SEC must avoid overstepping its mandate by striking a balance between providing investors with significant information and not burying them “in an avalanche of trivial information.”
Is Climate Change Reporting Within The Mandate?
Although the SEC’s rulemaking authority under Section 7 of the Securities Act is not strictly limited to material information, Section 7 narrowly authorizes the Commission to require such information “as being necessary or appropriate in the public interest or for the protection of investors.” As defined by the Commission and consistent with Supreme Court precedent, a matter is material “if there is a substantial likelihood that a reasonable investor would consider it important when determining whether to buy or sell securities or how to vote.” The question at issue here is whether this new proposal targets issues which the average investor would deem critically important in their investment decisions.
Materiality, as Commissioner Peirce notes, has served the SEC well as a general standard. However, Peirce believes “undermining [materiality] to accommodate ESG will harm investors.” Peirce’s main concern is that ESG standards are generally talked of in broad strokes “that obfuscate the immaterial nature” of many of the specific underlying disclosures included in the SEC’s proposal. The Proposal repeatedly calls for the disclosure of granular climate-related information by all public companies even if such information is immaterial under the materiality standard the Supreme Court handed down decades ago. In a final plea, Peirce urged the Committee to rethink the proposed mandates: “they are not akin to accounting standards, which serve clear, time-tested, universally understood objectives… having the SEC build a GAAP [Generally Accepted Accounting Principles]-like edifice around ESG standards would give investors a false sense of confidence in standards that are subjective, shifting, and sometimes even senseless.”
Does This Help Mainstreet Investors?
Commissioner Peirce’s comments lend credence to concerns held by others regarding the SEC’s extension of the concept of “materiality” as being applicable to an individual investor’s investment portfolio. Penny Somer-Greif, Chairman of the Committee on Securities Law of the Maryland State Bar Association, expresses the Committee’s concern that incorporating concepts such as individual risk tolerances and the impact of information with respect to an investor’s individual investment portfolio is “inconsistent with the manner in which materiality has been interpreted to date.” The proposal includes numerous statements supporting the proposed requirements because they ”could” help investors figure something out or “may” be important to investors, as opposed to disclosures in which there is a “substantial likelihood” investors would consider them important.
However, public demand for such requirements has been persistent, and the various voluntary reporting programs have proven to be inconsistent and lacking universal coherence. Shivaram Rajgopal, Professor of Accounting and Auditing at Columbia University, explains that companies who choose to voluntarily report climate data tend follow diverse frameworks, such as those proposed by the Task Force on Climate-Related Financial Disclosures, the Sustainability Accounting Standards Board, and the Global Reporting Initiative. To complicate matters, the most reputable independent rating agencies, such as the Institutional Shareholder Services group of companies, Morgan Stanley Capital International, and Sustainalytics, all rank different aspects of a company’s ESG footprint with varying degrees of success. As a climate conscious investor, Shivaram argues that the rigor, consistency, comparability, and verifiability of the proposed disclosures will be necessary to hold companies accountable for the promises they make in terms of carbon reduction.
Yet, as Penny Somer-Greif notes in her comments, much of the specific climate data being stipulated, such as GHG emission numbers, are not material because, as noted in the proposal, they are simply an “indication” of risk. Moreover, the complicated nature of such data makes it essentially unactionable to the average investor who lacks the climate expertise required to interpret and make use of it. For example, the proposal requires that registrants present Scope 1, 2, and 3 emissions both (i) disaggregated by each of seven constituent greenhouse gases (carbon dioxide, methane, nitrous oxide, nitrogen trifluoride, hydrofluorocarbons, perfluorocarbons, and sulfur hexafluoride) and (ii) in the aggregate, expressed in terms of carbon dioxide equivalent.
The SEC argues that “[b]y requiring the disclosure of GHG emissions both disaggregated by the constituent greenhouse gasses and in the aggregate, investors could gain decision-useful information regarding the relative risks to the registrant posed by each constituent greenhouse gas in addition to the risks posed by its total GHG emissions by scope.” But such diffuse data can only be made intelligible by plugging it into sophisticated climate models which few investors have the resources for, and thus, has little chance of producing “decision-useful” information. While it is important that the SEC consider what information investors want registrants to provide, Somer-Greif does not believe it is appropriate for the SEC to compel all companies to disclose information only a subset of sophisticated investors are demanding because they are not getting the “comparable” information they want from such companies.
The SEC’s Jurisdiction
In West Virginia v. Environmental Protection Agency, the Supreme Court ruled that Congress, not a federal administrative agency, has the power to decide issues of major importance to the nation’s welfare. Although Congress had granted the EPA broad authority over questions of environmental protection, the Supreme Court found provisions within the Clean Air Act, which attempted to effect sweeping changes in the nation’s power grid, to be strictly outside the bounds of the EPA’s jurisdiction.
Similarly, the Supreme Court recently ruled that a vaccine mandate issued by the Occupational Safety and Health Administration (OSHA) “significantly expand[ed] OSHA’s regulatory authority without clear congressional authorization.” Specifically, the Court stated: (a) the mandate was “a significant encroachment into the lives—and health—of a vast number of employees” constituting an exercise of agency “power of vast economic and political significance” requiring clear congressional delegation; and (b) OSHA’s enabling statute, which empowers OSHA “to set workplace safety standards, not broad public health measures,” did not “plainly authorize” the mandate.
Here, the question is whether climate change disclosure provisions are similarly outside the SEC’s jurisdiction, or whether the SEC has a valid scope of authority over such questions.
Grounds For Challenge
Given the almost certain chance of legal contest, opponents of the proposal will likely rely on the Supreme Court’s reasoning in West Virginia v. EPA and Nat’l Fed. of Indep. Bus. v. OSHA in this case. However, some believe this won’t be such an easy task. Scott Schang, director of Wake Forest Law’s Environmental Law and Policy Clinic, noted that Section 111(d) of the Clean Air Act “was stretched quite far by the Obama EPA because they simply didn’t have any other good alternatives to address utilities’ GHG emissions.” Schang believes it will be much easier for the SEC to demonstrate and explain to a skeptical court the nexus between its authorizing statutes (the Securities Act of 1933 and Exchange Act), and the climate rules than for the EPA’s Section 111(d) authority.
However, there is nothing explicit in the SEC’s authorizing statutes which encompass environmental regulation other than statutes concerning “investor protection” or the “public interest.” The Supreme Court has “consistently held that the use of the words ‘public interest’ in a regulatory statute is not a broad license to promote the general public welfare; rather, the words take meaning from the purposes of the regulatory legislation.” Consequently, the SEC’s authority to regulate “in the public interest” is not a standard without ascertainable criteria, rather, it is essential to look towards the purposes for which the relevant statutory schemes were adopted.
Congress may only authorize an agency to regulate in an area so long as it gives the agency an “intelligible principle” on which to base the regulations. However, as noted above, the phrases of “investor protection” or “public interest” are unlikely to serve as any intelligible principles regarding matters of climate. Moreover, it is likely that this topic is outside the Commission’s area of expertise. As noted by Patrick Morrisey and Mark Brnovich, Attorneys General for West Virginia and Arizona, “if anything, the Commission is even less equipped to regulate in areas concerning climate change than EPA… this issue—climate change—is also the same issue deemed vitally important in West Virginia v. EPA.”  Morrisey and Brnovich further argue, “[i]f this sort of regulatory overreach does not constitute a sweeping policy judgment on a major question, then we struggle to see what would.”
The “major questions” doctrine arose from the concept that important choices of social policy should be made by Congress. An agency’s exercise of regulatory authority over a major policy question of great economic and political importance requires a clear delegation of authority by Congress. Congress, with some exceptions, has restricted the subjects of mandatory disclosures to financial statements, core business information, directors and management, and a description of the securities being sold.
Yet, as the SEC itself pointed out, when Congress wished to later expand the subject matter of mandatory disclosures beyond strictly financial matters, it specifically did so by statute, including for topics such as executive compensation, corporate governance, and conflict minerals. Moreover, in 2016, the SEC acknowledged that the Commission “generally is not authorized to consider the promotion of goals unrelated to the objectives of the federal securities laws” and that “a specific congressional mandate” would be required before it adopted rules ordering climate change and ESG-related disclosures. However, no such congressional mandate has been issued.
If the SEC hopes to get this proposal implemented, it has a long journey ahead of it. The SEC’s declared authority to regulate the new territory of climate change steps on a subject matter doubtfully within its mandate, and without any additional congressional grant of authority. If the Commission adopts the proposal as it stands, many companies will be unlikely or unable to implement the necessary protocols to meet the new reporting requirements, especially for those businesses which have little material exposure to climate related concerns.
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