Last week, a House Financial Services subcommittee held a hearing with the ominous title "Oversight of the SEC's Proposed Climate Disclosure Rule: A Future of Legal Hurdles." Billed as oversight, the hearing certainly highlighted the gauntlet that the SEC would have to run if the rules were adopted as is. Not that SEC Chair Gary Gensler wasn't already well aware that the climate proposal is facing a number of legal challenges. Will this gentle "reminder" by the subcommittee, together with recent court decisions, perhaps lead the SEC to moderate some of the most controversial aspects of the proposal, such as the Scope 3 and accounting requirements? The witnesses were a VP of the National Association of Manufacturers, counsel from BigLaw, a farmer and an academic.
[Based on my notes, so standard caveats apply.]
A common theme at the hearing was the issue of the SEC's legal authority to adopt the proposal. The witness from the law firm contended that the SEC did not have the authority, citing the "major questions" doctrine enunciated by SCOTUS in West Virginia v. EPA. (See this PubCo post.) Not to mention that familiar refrain: that, if adopted, the proposal would, in his view, violate the First Amendment by compelling speech.
SideBar
Government-compelled speech in violation of the First Amendment seems to be a favorite argument of some business groups. For example, the issue was raised by NAM in connection with its challenge to the Rule 14a-8 regulatory process for shareholder proposals (see this PubCo post) and by the Chamber of Commerce in its challenge to the stock repurchase disclosure rules (see this PubCo post). You may remember that NAM, the Chamber of Commerce and Business Roundtable took on the SEC over the conflict minerals rules with some success on precisely this issue. In April 2014, the D.C. Circuit issued a decision in National Association of Manufacturers, et al. v. SEC, concluding that that the conflict minerals rules "violate the First Amendment to the extent the statute and rule require regulated entities to report to the Commission and to state on their website that any of their products have 'not been found to be "DRC conflict free."' Why? Because, by "compelling an issuer to confess blood on its hands, the statute interferes with that exercise of the freedom of speech under the First Amendment." (See this PubCo post.) As a result, Corp Fin issued guidance advising that companies "should comply with and address those portions of Rule 13p-1 and Form SD that the Court upheld." On remand in 2017, the D.C. District Court entered final judgment, holding that the statute and related rules and forms violated the First Amendment to the extent that they required regulated entities to report to the SEC and to state on their websites that any of their products "have not been found to be 'DRC conflict free.'" (See this PubCo post.) Following that action, Corp Fin issued an Updated Statement on the Effect of the Court of Appeals Decision on the Conflict Minerals Rule that provided substantial relief to companies subject to the rule. (See this PubCo post.) For additional discussions of the issue of "compelled commercial speech" under the First Amendment, see the PubCo posts of 4/14/14, 7/16/14, 7/29/14, 8/18/15, 3/13/17.
What's more, the counsel contended, Congress delegated authority over climate to the EPA, not the SEC. Besides, the SEC has already issued guidance on the disclosure issue, rendering the rules unnecessary. The proposed rules would effectively require companies to engage outside expertise and would harm investors by requiring disclosure of a lot of useless information, obtained at great expense, with no benefit, he said. Moreover, he argued, the proposal would violate the APA because the SEC's cost-benefit analysis was inadequate, much like the analysis for SEC's stock repurchase disclosure rules that were just overturned by the Fifth Circuit (see this PubCo post). Finally, he suggested that, if adopted, the proposal would discourage many companies from going public. Overall, he said, the climate proposal represented an "undemocratic power grab."
Some of the subcommittee members also chimed in on the issue of legal authority. The subcommittee chair contended that nowhere had Congress delegated the issue of climate to the SEC, and SCOTUS was now in the process of reexamining the boundaries and the balance between agencies, Congress and the judiciary in the recent cases on Chevron deference. (See this PubCo post.) The chair also agreed about the inadequacy of the cost-benefit analysis, noting that the SEC's analysis had dramatically underestimated the potential costs involved. There may well be a number of SEC rules that are overturned on this basis, he said, consistent with the Fifth Circuit decision to vacate the SEC's stock repurchase disclosure rules because of an inadequate cost/benefit analysis. Other Republican members agreed that the action by the Fifth Circuit may find parallels here. The simple finding that the rules may provide a benefit is just not enough; the SEC must substantiate that there is a need for the rule. The chair also expressed concern about the privacy of the data provided through the value chain—unintended consequences are often the hardest to address, he warned.
The representative from NAM railed against the cost to businesses of all regulation, giving an aggregate figure of $3 trillion every year and $29,000 per employee annually; the number for smaller companies was even higher. The climate proposal would add more, but much of the information required was immaterial and far exceeded what investors needed to know; it was unclear that it would benefit investors. Much of the cost of Scope 3 would fall on smaller companies, he said, yet the SEC has admitted that it can't quantify the cost of Scope 3 compliance. While the SEC has purported to quantify the cost of compliance with the proposal's accounting requirements at $15,000 annually, he contended that there was no way that would be the case.
Republican subcommittee members agreed that the proposal could have a damaging impact on business and that it disregarded the standard for materiality. Moreover, public companies, they said, are already required to disclose material information. One subcommittee member characterized the proposal as a "weapon" that the SEC will use to punish companies with fines. In addition, another member thought that the rules would result in a misallocation of capital. One member said that the TCFD framework, on which the SEC proposal relies in part, was written by activists; while many companies use it voluntarily, the proposal would mandate its use. One member characterized the proposal as "hyper-aggressive," the most aggressive since Dodd-Frank. He advocated restructuring the SEC so that there would be a 3/3 balance, eliminating the position of Chair. In his view, Gensler was trying to mess up the markets. And in this case, the SEC was definitely acting outside of its lane.
SideBar
In 2023, some Republican House members proposed a bill to "stabilize" the SEC, the SEC Stabilization Act (H.R. 4019). What do they mean by that? First and foremost would be removal of the current "tyrannical"—their word, not mine—SEC Chair, Gary Gensler, "following his long series of abuses that have been permitted under the current SEC structure," according to the bill sponsor's press release. The actual bill would establish the office of Executive Director and implement a structure similar to that of the bipartisan Federal Election Commission, increasing the size of the SEC to six, with an even party split, thus "protecting U.S. capital markets from any future destabilizing political agenda"—or ensuring permanent gridlock, depending on your point of view. Whether that structure is appropriate for an agency that oversees the securities markets, as opposed to federal elections, is a big question. As described in this article in Federal Securities Law Reports, the dominant structural model for independent agencies is a three-two split, "with a partisan balance that matches the political views of whichever political party holds the White House....The purpose of the 3-2 commission is largely to allow an administration to pursue its regulatory goals, a generalized purpose that courts have tended to uphold when a new administration seeks to repeal the rules adopted by a prior administration's agency leadership." (See this PubCo post.)
The proposal's Scope 3 requirement drew a lot of attention. The witness who runs his family farm said that the Scope 3 requirement would adversely affect his farm; even though it is a private company, it is in the value chain for public companies and would, in effect, be indirectly compelled to provide responsive data. While, at the farm, they have taken some actions to support the environment, they do not have the staff to collect and calculate the data responsive to Scope 3. And, farms will, in many cases, he said, be required to absorb the costs, perhaps eventually leading to more consolidation. The subcommittee's ranking member reminded the group that Gensler had said in prior testimony that it was not the SEC's intent to subject private farmers to the reporting requirements. The subcommittee chair responded that intent is one thing and actual application is quite another. In his view, a lot of farmers will be scooped up the regulations. A number of subcommittee members declared their farming bona fides, with several Republican members expressing their concerns about the impact of the proposal on farmers. Investors, the chair said, are just one segment of the universe.
SideBar
During testimony before the Senate Banking Committee in 2022, Senator Jon Tester remarked that, as a farmer, he appreciated the issue of climate change: because of climate change, in the last two years, his farm had had its two worst harvests ever. But, he said, he also understood the burden of reporting. While a small farm like his would not be subject to a direct reporting mandate, he was still concerned that, under the proposed requirements for Scope 3 reporting, public companies to which he sells his wheat would need to comply, and, as customers, they will be insisting that he provide them with data. But he and other farmers like him don't have the time and ability to provide that data—it would be a tremendous burden. Gensler replied that he understood the concern; this issue had been raised frequently in comments the SEC received. First, Gensler said that it was not necessary for his public company customers to obtain the data from Tester nor was it the SEC's intent—they could simply use estimates and rely on safe harbors. (But see that, in the release, the SEC identifies first as a data source for Scope 3 disclosure emissions those data reported by parties in the company's value chain. See this PubCo post.) He said they were looking at the comments—and there were plenty in this area—and trying to achieve a balance. He agreed that this topic required a second look to examine the impact on private actors—there was no intent to touch farmers and ranchers. (See this PubCo post.)
Similarly, in 2023, during testimony before the House Subcommittee on Financial Services and General Government, a committee member suggested that the SEC's climate proposal—especially a Scope 3 mandate—reflects a "true weaponization of the department" and hurts Iowa farmers. Another member said that, even if farmers aren't public companies and thus directly regulated, they still would be called upon to comply by customers as part of the supply chain, if the mandate for Scope 3 disclosure were adopted. Scope 3 reporting will be expensive, and companies say they can't afford it, especially small companies in the supply chain. Gensler again responded that the SEC's remit is public companies. There was no intent to ask for disclosure from private Iowa farmers. The SEC received over 15,000 comments—the most ever—including comments from 49 farm bureaus. The staff is currently considering the comments. (See this PubCo post.)
The subcommittee's ranking member characterized these criticisms as an "attack on investor protection." Businesses have already begun to experience the negative effects of climate change, citing the example of a plant that recently had to close down because of overuse of groundwater. The disclosures that companies make now are very general and vague, and lack standardization. The SEC's proposal would address those issues. The SEC, he argued, is not seeking to regulate climate. Regulations related to climate itself have been left to the EPA, but the SEC has authority over disclosure. In addition, he observed, the SEC may seek the assistance of experts. When the oil and gas disclosure regulations were codified, the SEC relied on industry experts. Here, the SEC used the technical expertise of bodies such as the Task Force on Climate-Related Financial Disclosures. All agencies will address the issue of climate in different ways. This attack, he said, was just "part of the Republican playbook"; they were offering no constructive solutions.
Other Democratic members contended that the SEC's authority was clear from the securities laws adopted in the 1930s, as well as from legislative history and rulemaking practices. Congress has relied on the SEC's expertise, giving the SEC broad discretion to determine what types of rules are required and how to calibrate them. If it had wanted, Congress could certainly have passed restrictions on the SEC, but it hasn't done so. In addition, one member observed, no court has ever invalidated an SEC disclosure rule on the basis that the SEC had exceeded its authority. In terms of the impact, it was important to keep in mind that thousands of companies would already be required to comply with climate disclosure requirements, including Scope 3, that have been adopted in Europe and in California. In those cases, the marginal cost of complying with the proposal would likely be zero. Others reiterated that climate change information is warranted because it is material. Climate change has led to irreversible damage, with major insurers pulling out of several states because of the financial risk. Even under Basic v. Levinson, one subcommittee member argued, a reasonable investor would view it as important. Further, one member also pointed out that the SEC has gone to great lengths seeking feedback; so far there have been 372 meetings with staff and 178 with the Chair.
The witness from academia concurred that the SEC's rules were much needed; they were not concerned with regulating climate change, but instead were designed to provide valuable information to investors, particularly about transition and other climate risks that companies face, such as the water crisis. Many companies want to see new rules, he said, because they want legal certainty. The problem with voluntary disclosure, he said, in addition to lack of comparability, was that companies were often reluctant to disclose negative information. Rules would mandate that disclosure, including information regarding risk management. In addition, he argued, the rules would help with market efficiency because they facilitate price accuracy and discovery. Unlike in Europe, the proposal does not require the application of double materiality and adds several safe harbors.
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