ESG Disclosure Rules and the SEC’s Mission

Cydney S. Posner is special counsel at Cooley LLP. This post is based on her Cooley memorandum. Related research from the Program on Corporate Governance includes The Illusory Promise of Stakeholder Governance by Lucian A. Bebchuk and Roberto Tallarita (discussed on the Forum here); Will Corporations Deliver Value to All Stakeholders? by Lucian A. Bebchuk and Roberto Tallarita; Restoration: The Role Stakeholder Governance Must Play in Recreating a Fair and Sustainable American Economy—A Reply to Professor Rock by Leo E. Strine, Jr. (discussed on the Forum here); and Stakeholder Capitalism in the Time of COVID, by Lucian Bebchuk, Kobi Kastiel, and Roberto Tallarita (discussed on the Forum here).

Earlier this week, SEC Chair Gary Gensler gave the keynote address for an investor briefing on the SEC Climate Disclosure Rule presented by nonprofit Ceres. In his remarks, entitled “Building Upon a Long Tradition,” Gensler vigorously pressed his case that the SEC’s new climate disclosure proposal (see this PubCo post, this PubCo post and this PubCo post) was comfortably part of the conventional tapestry of SEC rulemaking. Growing out of the core bargain of the 1930s that let investors “decide which risks to take, as long as public companies provide full and fair disclosure and are truthful in those disclosures,” Gensler observed, the SEC’s disclosure regime has continually expanded—adding disclosure requirements about financial performance, MD&A, management, executive comp and risk factors. Over the generations, the SEC has “stepped in when there’s significant need for the disclosure of information relevant to investors’ decisions.” As has been the case historically, the SEC, he insisted, “has a role to play in terms of bringing some standardization to the conversation happening between issuers and investors, particularly when it comes to disclosures that are material to investors.” The proposed rules, he said, “would build on that long tradition.” But has everyone bought into that view?


Gensler surely felt compelled to focus on positioning the rulemaking as well within SEC traditions given the bashing the proposal has received from some corners of the political universe, perhaps even auditioning some arguments in preparation for one or more court challenges. Even before the proposal was released, the WSJ reported, some Republicans had contended that “it isn’t the SEC’s job to mandate nonfinancial disclosures.” In addition, the article continued, some industry organizations “told the SEC it didn’t have legal authority to compel disclosures and impose its value judgments.” One Republican state attorney general “wrote that ‘West Virginia will not permit the unconstitutional politicization of the Securities and Exchange Commission. If you choose to pursue this course we will defeat it in court.’”

After release of the proposal, a group of Republican Senators wasted no time in submitting a comment letter to the SEC, contending that the “proposed rule is not within the SEC’s mission to protect investors, maintain fair, orderly, and efficient markets, and facilitate capital formation,” nor was it clear to the Senators “where the SEC has derived this drastic change in authority. The SEC is not tasked with environmental regulation, nor has Congress amended the SEC’s regulatory authority to pursue the proposed climate disclosures. Further, there are serious questions about whether the SEC has the technical expertise to assess climate models and underlying assumptions used in companies’ metrics and disclosures.” (Of course, in a case before SCOTUS this term, West Virginia v. EPA, SCOTUS is being asked to decide whether, under the “major questions doctrine,” even the EPA has authority under the Clean Air Act to regulate GHG emissions at power plants without explicit authorization from Congress—but that’s a story for another day. See this article in the NYT.) Existing regulations, the Senators said, should do the trick, and many companies are providing relevant information voluntarily, so why do we even need this proposal? What’s more, the Senators contended, the “proposed new required disclosures fail the materiality test and undermine this important standard. Moreover, requiring the disclosure of non-material information runs afoul of the First Amendment prohibition against compelled speech. After failed attempts to enact radical climate policy via legislation, this rule is yet another example of the Biden Administration’s efforts to have unelected bureaucrats implement its preferred agenda through regulation.” Not to mention the enormous costs imposed on companies, their suppliers and vendors, they continued.

And members of the House have also submitted a comment letter, similarly opposed to the proposal, asking for the proposal to be “immediately tabled.” They too contend that the proposal is outside of the SEC’s “historical purview” and was undertaken “to engage in environmental policy.” The proposal, they argue, would not only “add additional red tape and bureaucracy that would be extremely burdensome, if not impossible, for many public companies to fully comply with, but it would also far exceed the authority that Congress explicitly granted the SEC.” Taking a stab perhaps at a “compelled commercial speech” objection (which was, as discussed in this PubCo post and this PubCo post, the basis on which the conflict minerals rules were held to violate the First Amendment, by compelling an issuer to “confess blood on its hands”), the House members assert that it is apparent that the climate disclosure rules “would only be used to smear these companies…. Ultimately, the SEC’s actions would act to undermine and shame public companies, not to provide investors with necessary financial disclosures.” Not only that, the House members asserted, but “at a time of global turmoil, when energy prices are at decade highs,” the SEC’s proposal is just “wrapping climate activism in financial regulation [which] will only further exacerbate our current energy crisis and do nothing to help everyday Americans heat or cool their homes or lower prices at the gas pump.”

The U.S. Chamber of Commerce focused its criticism on materiality, saying that it “is concerned that the prescriptive approach taken by the SEC will limit companies’ ability to provide information that shareholders and stakeholders find meaningful while at the same time requiring that companies provide information in securities filings that are not material to investors. The Supreme Court has been clear that any required disclosures under securities laws must meet the test of materiality, and we will advocate against provisions of this proposal that deviate from that standard or are unnecessarily broad.”

In addition, Gensler continued, climate “disclosures are already happening,” and many of these disclosures are already aligned with the TCFD framework and the GHG Protocol, frameworks on which the proposal relies. The TCFD framework, he noted, was the work of “30-plus market folks (not government officials) who came together to create a climate disclosure reporting framework.” Currently,

“investors representing literally tens of trillions of dollars support climate-related disclosures because they recognize that climate risks can pose significant financial risks to companies, and investors need reliable information about climate risks to make informed investment decisions….That information could influence shareholders’ evaluations, risk management, or investment decisions to buy or sell a security and how to vote on a merger or other proxy vote. Companies and investors alike would benefit from the clear rules of the road in the release, particularly as those rules reflect what is becoming widely accepted across the globe. It makes sense to build on what so many companies are already doing to enhance the consistency, comparability, and decision-usefulness of these disclosures for investors.”

Gensler next turned to some specifics about the proposal. Why did the SEC propose to include the disclosures in SEC filings where they would be treated as “filed”? Because, he said, that’s where “Investors look for relevant information…when assessing an investment decision.” Although he recognized that there were “some costs to this,” on balance, Gensler pointed to benefits for investors “because there are more controls around those disclosures,” with a framework required under SOX 302. In addition, that is the approach taken by some other rulemaking organizations, including the International Sustainability Standards Board, which has, since the issuance of the SEC’s proposal, proposed its own global climate-related disclosure requirements that would also include climate disclosures as a part of general purpose financial reporting.

With regard to components of the proposal, the “first is bringing consistency and comparability” to climate disclosures. Second, the proposal would require “disclosure for companies that set targets or use internally developed target plans, transition plans, scenario analyses, or carbon pricing as part of their risk management process….It’s up to a company to determine whether to have a target, transition plan, scenario analysis, or carbon pricing. If a company chose not to make those statements or use those tools, no disclosure would be required. The decision on whether to make these statements or use these tools, though, remains entirely up to you as the company.” Safe harbors would also be available for forward-looking statements. Thus, the reporting regime would be “disclosure based,” not “merit based,” and the “design of the proposal is consistent with those long traditions and the law; with concepts of investor decision-making and related materiality; and with what companies are already doing based on the TCFD and GHG Protocol frameworks.”

In addition to climate-related financial statement metrics, the proposal would mandate disclosure of certain GHG emissions data—Scope 1 and Scope 2 for all companies and Scope 3 for companies other than smaller reporting companies and only if those emissions were material or if the company had made a commitment that involved Scope 3 emissions. Because methodologies for Scope 3 data were not as well developed as for Scopes 1 and 2, Scope 3 disclosures would be phased in, smaller reporting companies would be exempt and a new liability safe harbor would be available for Scope 3 disclosures.


This paper, The SEC’s Climate Disclosure Proposal: Critiquing the Critics, from a law professor at Emory University, argues that the new climate disclosure proposal “is firmly grounded within the traditional SEC disclosure framework that has been in place for close to nine decades. The Proposal is certainly ambitious (and overdue), but it is by no means extraordinary.” The author begins by suggesting that one of the standard arguments against climate disclosure regulations—that the disclosure is intended for stakeholders, not shareholders—actually sets up a false binary choice: just because the proposal has social relevance does not cancel out “its clear-cut financial relevance.” For example, the proposal “draws on technical frameworks for financially-material disclosure,” the TCFD and the GHG Protocol. The members of the team behind the TCFD are investors, bankers, accountants, insurance companies, with no environmental NGOs represented. While the author agrees that the SEC does not have the depth of expertise on climate-related matters that the EPA may have, that level of expertise isn’t necessary here:

“the SEC is not setting GHG emission limits, calculating carbon trading prices, drawing up climate transition plans, or setting climate resilience standards for businesses. The SEC’s Proposal is limited to disclosure—and only disclosure—on a technical topic, and the SEC has decades-long experience handling disclosures on technical topics. For example, the SEC is not an energy regulator, but it drew up a specialized disclosure framework for oil and gas extraction activities in the 1970s (with help from expert groups, much like it has done here), and it has administered this framework successfully since then.”

The author’s strongest ammunition, however, is reserved for the persistent criticism, discussed above, that the proposal “goes beyond the authority given to the SEC by Congress because the rules are too prescriptive, not rooted in ‘materiality’…, and because Congress has not directed the SEC to pursue rulemaking on this particular topic.” Notably, the question of “what it means for the SEC to act as ‘necessary or appropriate in the public interest or for the protection of investors’” has come under the spotlight. Here, the author points to Schedule A of the Securities Act, which “prescribes 32 categories of information” required in registration statements, as well as the delegation to the SEC of the authority to waive any of the categories and to mandate other information that the SEC “may by rules or regulations require as being necessary or appropriate in the public interest or for the protection of investors.” That’s the source of the authority for Reg S-K, the author observes. The author highlights that Congress did not impose any materiality requirement; in fact, Congress required disclosure of information that many today would find financially insignificant, even translated into today’s dollars. Moreover, “Congress calibrated Schedule A to the particular risks of the time, with abuse by public utility holding companies being one.” Accordingly, the author contends, “[b]ased on the delegation of authority and the Schedule A template, the SEC today should, similarly, develop disclosure requirements that take into account contemporary realities.” Relying on this authority dating back to 1933, the SEC has, “decade after decade, built out a detailed disclosure regime aimed at protecting investors, which covers a number of matters that are not mandated by Schedule A or subsequent acts of Congress. These matters include executive compensation, related-party transactions, asset-backed securities, and various technical industry-specific items…While the subject matter of the SEC’s new Proposal—climate change— implicates existential threats to businesses, the economy, and human habitats, from the vantage point of securities regulation, the Proposal is simply part of a tradition spanning nine decades.”

With regard to issues of “materiality,” the author contends that cases like Basic and TSC Industries deal with whether, in the past, the issuer had a legal duty to disclose particular information under specific circumstances. Accordingly, these materiality tests apply “to an ex post liability determination, not to an ex ante policy choice by a regulator.” Although the SEC regularly invokes these cases “for the sake of consistency,” it is not surprising, the author suggests, that “neither TSC Industries, nor Basic, nor any other Supreme Court case touches on or limits the types of information the SEC is empowered to require when it promulgates disclosure rules.” In addition, the author asserts that “[w]hen the D.C. Circuit has struck down SEC rules, it has been for failure to carry out adequate cost-benefit analysis, and never due to a finding that the challenged rule lacked materiality.”

While the cases do not impose a “formal constraint on SEC rulemaking,” the author does not mean to suggest, however, that they are “irrelevant to SEC rulemaking. The SEC should be (and has been) guided by the general materiality of a given subject matter when deciding whether to adopt new disclosure rules.” And once the SEC determines a “general subject area” is material to investors, it usually develops a detailed disclosure framework and guidance to provide “consistency, comparability, and reliability” of companies’ disclosures. Here, the SEC’s climate proposal “appears both justified and consistent with established practices.” The author provides an extensive analysis of the application of materiality in this context. For example, the SEC has repeatedly indicated that the largest institutional investors and asset managers—certainly representative of reasonable, financially motivated investors—view climate disclosure as highly important to their investment decisions and have endorsed the TCFD framework. He also criticizes as a “red herring” the contention that SEC disclosure regulations must elicit information that is “universally material,” an “incredibly high bar that few, if any, of the SEC’s existing disclosure rules would meet.” In support, he points to a footnote in the dissent of Commissioner Hester Peirce in which she indicates that “long-settled rules on executive compensation, related-party transactions, and environmental litigation do not meet the materiality standard (as she understands it).”

With regard to the contention by some critics that the proposal would compel commercial speech in violation of the First Amendment, which determination depends in part on whether the compelled disclosure is “purely factual and uncontroversial,” the author observes that, just because “opponents of the SEC’s climate disclosure initiative made it controversial well before the contours of the Proposal became known, this does not mean that the actual information required by the actual Proposal is controversial, burdensome, or unjustified.“ Although he argues that the proposed climate disclosure rules are none of those, he recognizes that “the First Amendment arguments deserve dedicated attention because they could be a risk factor not only for climate-related disclosure rules, but for other disclosure rules as well.“

In conclusion, the author observes that climate change is an “existential phenomenon, which entails sizeable but underappreciated economic risks. Even though disclosure will not solve the problem of climate change (and no one is claiming that it could), corporate disclosure would certainly bring to light the effects of climate change on firm valuations in the real economy and, in turn, enable market participants to adjust those valuations accordingly….While we can quibble with certain choices on the margins, the SEC’s new Climate Disclosure Proposal is fairly standard on the whole, and well within the traditional parameters of the decades-old securities disclosure regime.”

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