The SEC must be stopped from taking this unauthorized, detrimental action.
The final rule will likely expose the SEC to a torrent of legal challenges.
T he Securities and Exchange Commission (SEC) is finalizing a mandatory climate-disclosure rule for public companies — perhaps the costliest regulatory mandate in its entire 90-year history. In fact, the rule represents the first SEC-inspired disclosure that compels secondary information beyond a company’s present and prospective financial performance.
Beforehand, disclosures were inspired by materially relevant information from the perspective of the company’s board and managers. Today’s climate-disclosure rule deviates from this tradition by compelling largely theoretical information on climate risks from an outside stakeholder’s perspective.
After repeated setbacks, the SEC aims to finalize its rule this spring, and the Office of Management and Budget has reserved space in the Federal Register for an April release date. The Commission will officially vote on whether to finalize the rule by next week.
There are major problems with the proposed rule.
Public companies and their private suppliers face significant financial costs if the rule is enacted. The SEC estimates a 250 percent increase for disclosure costs from the climate rule alone, raising the annual amount to $10.2 billion.
The average per-firm costs for producing climate disclosures amount to $864,864 across the 7,400 reporting companies, in addition to compliance costs for private entities (which would not otherwise be subject to the SEC’s control) across a firm’s value chain. As a result, private firms would be under immense pressure to provide the registrant with accurate data on their emissions for inclusion with the actual disclosure.
This cost burden will fall primarily on farmers, ranchers, facilities, and distributors who provide products and services to the reporting firms across their value chain. The rule’s Scope 3 requirement would compel emissions data from these parties regarding the upstream and downstream activities they conduct on behalf of the registrant.
The SEC’s estimated multi-billion-dollar cost is too conservative. It fails to factor in many indirect and long-term costs incurred to implement the rule, such as deterring private firms from going public, an estimated tens of billions in GDP loss, and reduced innovation. The rule will drastically increase the annual workload burden for public companies by 39 million hours. Even the SEC will be forced to bolster its own staff just to solicit, analyze, and police the new disclosures.
It is also clear that the SEC’s rule will benefit politically favored stakeholders that encouraged the rule. Proxy-advisory firms Glass Lewis and ISS were key influences in the SEC’s efforts to mandate climate disclosures. Both firms stand to benefit most from the climate-disclosure rule by selling their consulting services to affected public companies to ensure compliance with the very rule they helped inspire. This may explain why the environmental-disclosure recommendations provided by Glass Lewis and ISS closely align with requirements from the SEC’s rule.
Another problem is the agency’s complete departure from its own history of restraint on climate-change matters. Until now, the SEC resisted activist pressure from environmental groups to define climate risk as necessarily material to investors (companies already have an obligation to disclose anything that is material). The SEC went so far as to defend itself against intense environmental lobbying from the Natural Resources Defense Council (NRDC) during the height of the environmental-reform era in the 1970s. The SEC fought and won against the NRDC in federal court in 1979, resolute in its decision to refrain from mandating environmental-impact disclosures.
Sadly, the SEC today has caved to pressures from environmental NGOs. The most influential was the Task Force on Climate Related Financial Disclosures, which convinced the SEC to align its “scope” requirements with the Green House Gas Protocol, a globalized framework for quantifying and reporting greenhouse-gas emissions. However, the TCFD was officially disbanded last October and is no longer a relevant body on climate-change reporting.
Recent reports based on inside information from the SEC have suggested that the final draft of the rule will omit the Scope 3 requirement entirely, while paring back its Scope 1 and 2.
The good news is that the SEC will face an uphill battle to defend the proposed rule in court. The Supreme Court decided in 1976 what constitutes materially relevant information for U.S. investors. According to that decision, only important information that a reasonable shareholder would deem to be materially relevant could be required for financial disclosure. The SEC’s proposed rule violates that decision by substantially lowering the materiality standard.
This is no mere technicality. It will expose corporations to much greater liability when improperly disclosing or omitting perceived climate-change risks. Thus far, no court has ever deemed climate change to be a material factor when looking to the high standard established in 1976.
By expanding the materiality standard to accommodate what may be trivial climate-related concerns, these disclosures will flood shareholders with insignificant information that carries little financial value. This would inevitably expose companies to new areas of litigation risk. If companies are found to not include climate-related information that the SEC deems to be materially relevant, investors can sue them.
The Supreme Court’s ruling in Axon v. FTC (2023) may make it more difficult for the SEC to defend its proposed new rules. Axon provides a path for litigants to raise constitutional challenges against agency-enforcement actions without needing to go through protracted agency adjudication. Litigants are able to raise legitimate constitutional countersuits against the SEC before federal court, likely citing how the climate-disclosure mandate violates the “major questions doctrine,” from which courts will presume Congress did not delegate that huge power to the SEC. Congress has not authorized the SEC to regulate and reduce investor risk with regard to climate change.
The SEC also risks legal peril over the proposed rule’s lack of transparency. For example, one of the agency’s comment pages appears to omit any mention of the thousands of comments submitted in opposition to mandatory climate disclosures. Another comment page has also been left open far beyond its stated deadline, suggesting the possibility of procedural errors. If left unaddressed, the SEC may risk Administrative Procedure Act violations on the grounds that not every public comment was equally considered and factored into the final rule.
Suffice it to say, the final rule will likely expose the SEC to a torrent of legal challenges from firms negatively affected by the heightened compliance burdens, especially as many formerly unregulated firms will also have standing to challenge the SEC’s authority. And given recent Supreme Court decisions limiting the power of executive agencies, the SEC may find that its activism fervor will yield permanently curtailed authority rather than the expanded climate-policy role it seeks.
Either way, the SEC must be stopped from taking this unauthorized, detrimental action.