SEC’s new climate disclosure rule a slow-motion train wreck

The day that many observers of financial regulation have long been awaiting (and dreading) has come; the Securities and Exchange Commission (SEC) has voted to approve its final rule on disclosure of climate change-related information for public companies. Here was my initial statement on the rule:

The Securities and Exchange Commission’s final rule on climate disclosure spared Americans some of the worst features of its initial proposal, but the rulemaking itself will still be an expensive failure. Companies already have plentiful incentives and opportunity to provide potential investors with information about their energy use and climate strategy under the Commission’s existing, principles-based disclosure standard. The current majority on the Commission, however, has decided to put its thumb on the scale and declare climate-related information more important than any other topic. If the data the SEC is poised to require actually addressed real financial concerns by investors, it would already be covered by existing regulation and guidance, making the new rule unnecessary. Singling out data related to climate change by definition acknowledges that the Commission is engaging in environmental activism rather than financial regulation. Despite wisely jettisoning provisions like the controversial ‘Scope 3’ emissions disclosure requirement, the final rule approved this week is still highly vulnerable to court challenge. Relevant federal court precedent — such as West Virginia v. EPA (2022), which illuminates the emerging major questions doctrine — gives the new climate disclosure rule a very uncertain future.

After Republican SEC chairman Jay Clayton resigned from the Commission just before Christmas of 2020, Democratic Commissioner Allison Herren Lee began serving as acting chairman. While in that position, she published a request for public comment via a statement which included a list of fifteen questions those providing input might want to answer. In that statement, she wrote:

In May 2020, the SEC Investor Advisory Committee approved recommendations urging the Commission to begin an effort to update reporting requirements for issuers to include material, decision-useful environmental, social, and governance, or ESG factors. In December 2020, the ESG Subcommittee of the SEC Asset Management Advisory Committee issued a preliminary recommendation that the Commission require the adoption of standards by which corporate issuers disclose material ESG risks.

With that invitation, many concerned parties weighed in with their recommendations on the topic, including myself and my colleague Marlo Lewis, Jr. My comment focused on the legal and financial elements of the topic, while Marlo’s comment letter focused on the climate science questions inherent in the proceeding. Each was co-signed by representatives of several allied organization who joined our comments.

I addressed concerns about agency jurisdiction and appropriateness, how disclosure mandates might be substituting for climate policy that had failed elsewhere, and how the long-term uncertainties of climate science were a poor match for the much shorter time scales of the business strategy and planning process. I also mentioned one of the most common refrains from defenders of environmental, social, and governance (ESG) policy, which is that corporate America writ large was in favor of such proposals, so there was no reason for defenders of capitalism to be alarmed about them. In response, I wrote:

Advocates of greater regulation have suggested that the approval of prominent finance industry leaders validates the notion that mandatory disclosures would not be overly burdensome to registrant firms. Some market participants, however, have a direct financial interest in more bureaucracy and litigation, so they can be expected to approve of its expansion. Accounting companies, consultants, and law firms with compliance practices can be expected to welcome more disclosure requirements for self-interested professional reasons. Their approval is merely evidence of rent-seeking positioning in the regulatory process, not proof of the wisdom of increased regulation itself.

After the end of the comment period responding to acting chair Lee’s solicitation, the SEC took its time formulating an actual proposed rule, during which time President Biden nominated, and the Senate confirmed, former Commodity Futures Trading Commission head Gary Gensler as the agency’s new chairman.  Eventually, on March 21, 2022, Gensler announced a new notice of proposed rulemaking. In response to that announcement I wrote an article for National Review covering objections to the new rule, including the dissenting statement issued by Commissioner Hester Peirce. In my article I wrote:

The next issue is perhaps the most important of all: Does the SEC have the authority to do any of this anyway? The current proposal is a dramatic change to the agency’s standard operating procedure — both skeptics who oppose it and supporters who are praising it as a bold new initiative agree on that. But the question is whether it goes beyond the agency’s legitimate powers. Former SEC deputy general counsel Andrew Vollmer certainly thinks it does. In a detailed legal analysis published last August, Vollmer comes down squarely against the legitimacy of the agency’s foray into climate regulation, concluding that “even if climate-change information is material to investors, the SEC does not currently have statutory authority to make rules requiring companies to disclose it.”

I turned my initial reaction to the proposed rule into a short study. In that piece, I questioned the SEC’s good faith in proceeding with a rule aimed at climate change but pretending to be a consumer/investor protection measure. In a section titled “The Proposed Disclosures Are Climate Policy Masquerading as Materiality,” I wrote:

By introducing specific, prescriptive requirements rather than ones based on general materiality principles, the agency is trying to suggest that anything climate-related should be considered presumptively material. As SEC Commissioner Hester Peirce put it, the rule “tells corporate managers how regulators, doing the bidding of an array of non-investor stakeholders, expect them to run their companies.” [Emphasis in original]

Climate-related financial risk that is truly material, as some might well be, is already covered by existing SEC rules and guidance. What the agency is now proposing is to impose substantive environmental regulation thinly disguised as financial reporting. That does not protect investors. Instead, it picks legal, but politically disfavored, industries and targets them for destruction.

Eventually the comment deadline for the proposed rule arrived, and, as before, Marlo and I submitted our dual comment letters. Again, we were joined by a list of ally co-signers, this time numbering about five times as many as before. For maximum flexibility, I formatted my objections to the proposal both as a short summary and as a more detailed comment letter (both went into the record). The full letter made eight basic arguments:

  1. The Commission Lacks the Statutory Authority to Enact This Rule 
  2. Requiring Subjective and Disparaging Disclosure Is Unconstitutional
  3. The Proposed Rule Will Enable Rent-Seeking by Interested Parties
  4. The Proposed Disclosures Are Climate Policy Masquerading as Materiality 
  5. The Rule Does Not Pass Any Reasonable Cost-Benefit Test 
  6. Estimates of Physical Climate Risk Are Exaggerated 
  7. Estimates of Political Transition Risk Are Exaggerated 
  8. Estimates of Market Transition Risk Are Exaggerated

After submitting those comment letters, the SEC went quiet for quite a while as they reviewed the comments and wrote the final rule. There was widespread speculation that chairman Gensler was worried that a final rule similar to the original proposal wouldn’t stand up to federal court review. Writing for the Washington Examiner, American Enterprise Institute’s Ben Zycher presented his analysis:

The [climate disclosure] rule cannot be finalized as proposed because its legal weaknesses would yield highly visible embarrassment for the SEC, and the ensuing congressional hearings would not be friendly. A substantial revision of the proposed rule would require a second lengthy round of public notice and comment, perhaps dragging the process into or past the 2024 election. And depending on the details, the ultimate legal outcome would be far from certain.

But simply abandoning the rule altogether — the proper course — is unthinkable.

The weakness of the proposed rule demanded even more legal analysis, however, this time from my CEI colleague Stone Washington. His study went deeper into its statutory and constitutional deficiencies. He wrote:

Given its current strategy, the SEC is at high risk for future conflict with the legislative and judicial branches of government. The agency not only stands in defiance of Congress, it also ignores established judicial precedent by redefining the US Supreme Court’s interpretation of “materiality” in corporate disclosure.

The Commission’s proposed rule appears to be more heavily influenced by external non-governmental entities like the Task Force on Climate Related Financial Disclosures (TCFD) than the agency’s own expert judgment. The climate disclosure rule sets a worrying precedent for regulators to force companies to expend 39 million additional hours to provide paperwork in excess of what the vast majority of investors would deem financially relevant. In short, the rule would undermine the agency’s historic mission of protecting investors, maintaining fair, orderly, and efficient markets, and facilitating capital formation.

Stone also summarized the arguments from his paper with an excellent article for National Review.

The process by which new regulations are proposed and promulgated has run its course, so the next step is the litigation that the final rule’s release will no doubt inspire. Already, the first case has been announced. According to The Hill, West Virginia Attorney General Patrick Morrisey and nine other state attorneys general will sue to stop the rule from being implemented. It is unlikely that the legal challenge being led by Morrisey will be the only one, however. The Hill’s Taylor Giorno writes: “U.S. Chamber of Commerce Center for Capital Markets Competitiveness Executive Vice President Tom Quaadman said the business lobbying giant is ‘carefully reviewing the details of the rule and its legal underpinnings to understand its full impact.’”

Given the pace of similar litigation in the past, the ultimate fate of the SEC’s disclosure might not be known for years.