Climate Police Occupy Wall Street

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The Securities and Exchange Commission (SEC) on Monday, March 21, released its proposed rule to require every “registrant” (i.e., publicly-traded company) to provide more information about “climate-related risks” that are “reasonably likely to have a material impact” on its business, operations, or financial condition. A registrant must report three main types of information:

  1. The magnitude and probability of the financial losses it could incur due to the physical impacts of climate change.
  2. The company’s “transition” and “liability” risks—the financial losses it may incur as climate policies devalue or strand corporate assets and courts compel the firm to pay for climate change damages.
  3. The company’s “greenhouse gas emissions, which have become a commonly-used metric to assess a registrant’s exposure” to transition and liability risks.

For the vast majority of registrants, the potential material impacts of climate policy and litigation greatly exceed those of climate change.

The SEC acknowledges that “many companies have begun to provide some of this information in response to investor demand and in recognition of the potential financial effects of climate-related risks on their businesses.” So, why not just let the market sort things out? Not all shareholders demand climate-related information, and not all who do so seek the same range of information or level of detail.

The SEC appears not to tolerate such diversity. Corporate climate risk reports should be “consistent, comparable, and reliable.” To cure what ostensible market failure? Much voluntarily provided information is “outside of Commission filings,” published in “corporate sustainability” reports. What is wrong with that? Such reports are “not subject to the full range of liability and other investor protections that help elicit complete and accurate disclosure by public companies.” [Emphasis added]

The key word is “liability.” The SEC admits that the new rules’ potential costs “include increased litigation risk” (p. 305). The more information registrants are required to provide and certify as accurate and complete, the more opportunities there will be for “stakeholders”—including shareholder activists and state attorneys general—to challenge the company’s estimates, assumptions, models, and data. Climate risk assessments can be quite conjectural, which makes them highly contestable. That increases the risk of “climate-related” litigation.

Consciousness-raising—the imposition of groupthink by top management on corporate communications and employees—is another likely effect of the SEC initiative. Under the new rules (pp. 44-45), each registrant must disclose information about:

• The oversight and governance of climate-related risks by the registrant’s board and management;
• How any climate-related risks identified by the registrant have had or are likely to have a material impact on its business and consolidated financial statements, which may manifest over the short, medium, or long term;
• How any identified climate-related risks have affected, or are likely to affect, the registrant’s strategy, business model, and outlook;
• The registrant’s processes for identifying, assessing, and managing climate-related risks and whether any such processes are integrated into the registrant’s overall risk management system or processes;
• The impact of climate-related events (severe weather events and other natural conditions as well as physical risks identified by the registrant) and transition activities (including transition risks identified by the registrant) on the line items of a registrant’s consolidated financial statements and related expenditures, and disclosure of financial estimates and assumptions impacted by such climate-related events and transition activities.

Even for the meddling class, the SEC proposal is a landmark. A recent Law360 analysis describes the substantial institutional commitments companies must make to comply with the new requirements:

The rules are likely to lead companies to call on the accounting industry, auditors, and independent climate risk consultants for assistance. But there was a consensus that simply outsourcing the requirements won’t cut it.

If they haven’t already, public companies should be thinking about climate-related risk as “part of their overall risk management strategy,” said Charles Still, co-head of Bracewell LLP’s corporate and securities department.

“That means the involvement of the board and the audit committee. It means getting the C-suite focused on the ultimate need to disclose this sort of information,” Still said.

Companies will have to individually assess their needs, ultimately employing some combination of board input, in-house reporting teams, new staffers with climate-related expertise and third-party consultants, and ramping up training across all these areas.

“You’re going to have to designate a reporting team,” Still noted. “If you don’t have that in place right now, you may need to hire the people necessary to gather the information and report it.”

Sole Republican Commissioner Hester Peirce cut to the chase—the proposal is a jobs program for climate consultants and accountants.

More fundamentally, the proposal aims to align capital markets with the Biden administration’s agenda to achieve NetZero emissions by 2050. That is not its avowed purpose, of course, but the proposal obviously fits into the president’s “government-wide approach” to the “climate crisis,” which includes “promoting the flow of capital toward climate-aligned investments and away from high-carbon investments.”

More tellingly, when explaining the proposal’s rationale, the SEC lauds trillion-dollar institutional investors and financial institutions that advocate increased climate risk disclosure and “have formed initiatives and made commitments to achieve a net-zero economy by 2050, with interim targets set for 2030” (p. 165).

So, how might the SEC’s proposal shift capital away from fossil fuel-related investments?

First, increased disclosure facilitates activist naming-and-shaming campaigns against “polluting industries” and shareholder resolutions to divest fossil fuel-related assets.

Second, risk disclosures can be spun or litigated into confessions that a company’s business model is unsustainable in a carbon-constrained future. That can scare away investors and lenders, who typically shun businesses that lack assets of durable value. Declining capital and credit rates could in turn provoke shareholders to sue the company for fraudulently overpricing asset values. Such litigation could then further depress the company’s capital and credit ratings.

The goal of this cynical game is to impoverish fossil fuel investors. Adepts in Climatespeak call it “protecting shareholder value.”

So far, it is not working. The Biden administration’s war on American energy has lowered forecasts of future supply. That has increased current oil and gas prices. Higher prices have boosted fossil fuel-company profits and stock values.

There is no legitimate need for the new requirements. Registrants are already required by law and regulation to report environmental or policy risks that may be material from the standpoint of a reasonable investor, as the SEC’s 2010 guidance on climate-related disclosures explains. The extra information elicited by the proposal is unlikely to reveal anything of real value to corporate decision makers or shareholders.

Consider the following examples. If the registrant is an agribusiness, top management already knows that droughts and floods in specific regions may pose financial risks to the company or others in its value chain. If a registrant drills oil or fracks for gas, company executives—and most shareholders—already have a pretty good idea which politicians and pressure groups want to put the company out of business, and where they will seek to apply the screws.

The slick and glossy assessments touted by climate disclosure advocates typically rely on overheated climate models, inflated emission scenarios, and unrealistic depreciation of human adaptive capabilities. CEI’s comments on the prequel to the SEC’s proposal documented such failings in detail. You would never know from reading the Commission’s response to comments in its 506-page proposed rule.    

Some executives may want to use an internal carbon price to stress test potential new investments. But the market, not bureaucrats or activists, should determine whether such tests should be applied. Congress is no closer today to enacting a carbon tax, a national cap-and-trade program, or a national “clean electricity standard” than it was 10 years ago.

At a minimum, the new SEC requirements will divert corporate leadership’s attention and company resources away from developing new products, managing supply chains, cutting costs, and improving customer service.  

Before the SEC voted 3-1 to approve the proposal, Commissioner Peirce warned her colleagues that forcing executives to prioritize climate metrics and objectives would diminish their attention to financial metrics and objectives, which are what matter to investors, as distinct from ideologically motivated stakeholders. Not only shareholders but also “the whole economy, and all of the consumers and producers it sustains” could be harmed.

She also implied that by injecting the Commission into an area of bitter partisan controversy that is outside its field of expertise, the proposal would damage the SEC’s bona fides as an independent agency.

More importantly, Peirce argued that the proposal exceeds the bounds of the Commission’s statutory authority and may even run afoul of the Constitution:

This proposal steps outside our statutory limits by using the disclosure framework to achieve objectives that are not ours to pursue and by pursuing those objectives by means of disclosure mandates that may not comport with First Amendment limitations on compelled speech.

In this context, Peirce alluded to what has come to be called the “major questions” doctrine, which is much in play in West Virginia’s current challenge to the Environmental Protection Agency’s claim of authority to restructure entire industries and sectors for climate change purposes.

“We would do well to heed the admonition of the Supreme Court in a case involving the agency Congress charged with regulating the environment,” Peirce wrote. She then quoted Utility Air Regulatory Group v. Environmental Protection Agency (2014):

When an agency claims to discover in a long-extant statute an unheralded power to regulate “a significant portion of the American economy,” we typically greet its announcement with a measure of skepticism. We expect Congress to speak clearly if it wishes to assign to an agency decisions of vast “economic and political significance.”

For additional CEI analysis and commentary on the SEC’s climate risk disclosure proposal, see my colleague Richard Morrison’s new piece in National Review and my colleague John Berlau’s statement on the proposed regulations.