The full Scope of problems with the SEC’s climate disclosure rule

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I have a paper out today, examining the Securities and Exchange Commission’s (SEC) proposed rule on mandatory climate disclosures. The SEC’s rule seeks to radically redefine the traditional understanding of financial “materiality” by expanding the scope of its disclosure framework to accommodate climate change concerns.

Affected public companies will be required to disclose their direct, indirect, and value chain produced green house gas (GHG) emissions to the agency. The last and most controversial of these — known as “Scope 3” — will require the participation of many private suppliers that were formerly unregulated by the agency’s disclosure framework.

The paper explores how the climate disclosure rule represents the most costly and far-reaching piece of regulation ever proposed by the Commission. I explain how the rule diverges from the Commission’s prior history of restraint toward mandating climate-based disclosures from companies. This reckless shift in priorities places the SEC at odds with itself and with several federal court precedents.

Each cited case, spanning from several circuit courts to the Supreme Court, points to why the SEC cannot unilaterally expand its authority to require mandatory disclosure of climate-related information. The SEC exposes itself to great legal jeopardy if it decides to finalize and implement the climate rule in its current state.

The paper also explores the hefty compliance cost burden that the rule imposes for businesses. When breaking down the average per-firm disclosure costs and work-hour burden, we see that the climate rule will be exceedingly expensive. This will be especially detrimental to small public firms, which may not possess the institutional capacity to accommodate climate change metrics into its existing financial disclosures.

If the imposition of the obvious costs wasn’t bad enough, the SEC also fails to acknowledge the many hidden or indirect costs imposed by the rule. It will create a barrier to entry for new firms, while making it less likely for existing private firms to go public. The immense cost to meet the rule’s demands, coupled with the risk of being sued by the SEC for unsatisfactory disclosure, will be yet another factor persuading many firms not to go going public.

The SEC rule’s disclosure requirements are also highly intrusive. Public firms will need to quantify and report how climate change risk factors impact their governance, business model, and strategy. Already, public firms are scrambling to beef up their staff of lawyers and accountants in anticipation of the rule’s finalization.

Companies will likely need to hire climate scientists and ESG specialists just to develop sophisticated models capable of meeting the rule’s excessive demands. This pertains to the rule’s requirement for reporting companies to account for how climate change affects their business operations over short, medium, and long-term periods. Even companies that already have developed a scenario analysis with established climate risk protocols won’t be spared from the SEC’s disclosure requirements.

Despite repeated delays, the SEC is expected to finalize its climate disclosure rule sometime this year. Before that time, public companies should do their best to prepare for the monumental regulatory burdens that the rule will impose. Those opposed to the rule have a host of ways to challenge this mandate on legal grounds.

Read the press release here. Previous work on the SEC’s climate disclosure rule by my colleague Richard Morrison is here.