What’s “Controversial” About ESG? A Theory of Compelled Commercial Speech under the First Amendment

The SEC’s proposed climate disclosure rules create an opportunity to reflect on the limits that the First Amendment places upon securities regulation. As regular readers of this blog know, the SEC has proposed rules to make companies disclose their “climate risks” along with their greenhouse gas (“GHG”) emissions and certain climate-related financial metrics. Unlike existing rules, which require disclosure of climate-related matters when they have a material effect on business operations, the proposed rules largely dispense with the concept of materiality and, where they do not disregard it altogether, significantly alter its meaning. These rules thus raise the question of whether there is any limit on the SEC’s ability to impose them and, in particular, whether there is any First Amendment constraint on the SEC’s authority to mandate disclosures.

My paper, What’s “Controversial” About ESG? A Theory of Compelled Commercial Speech under the First Amendment, analyzes these questions. It argues that there is indeed a First Amendment limit to SEC action and that the proposed climate rules exceed those limits.

The SEC is, at its core, a regulator of speech. It makes rules about what companies and investors must say to one another. Yet the First Amendment prevents the government from, among other things, “abridging the freedom of speech.” The SEC is part of the government, and it abridges the freedom of speech. So, one wonders, is the SEC unconstitutional?

If the answer to this question is no, it’s not because the SEC is somehow immune from the First Amendment. No branch or agency of the government has First Amendment immunity. Instead, the SEC’s constitutional authority depends upon Supreme Court precedent granting deference to the regulation of “commercial speech.” Commercial speech—speech involved in the purchase or sale of a good or service—receives less First Amendment scrutiny so that the government can enact laws that protect consumers. The SEC’s mandatory disclosure regime, involving as it does the purchase and sale of securities, operates under this paradigm.

But there is a catch. Regulations compelling commercial speech receive deferential review only when they are “purely factual and uncontroversial.” The “uncontroversial” requirement works to ensure that the regulation is motivated solely to protect consumers. It is a pretext check. Applied to the SEC, this means that only regulations that are plainly grounded in investor protection count as uncontroversial and therefore entitled to deference. Regulations aiming at some other purpose are controversial and therefore subject to heightened scrutiny.

This brings us back to the SEC’s proposed climate disclosures. Are they controversial? Yes, they are.

My paper offers three independent bases for concluding that the SEC’s proposed climate disclosures are controversial. It argues that the SEC’s mandatory disclosure rules are controversial and therefore ineligible for judicial deference because they impose a political viewpoint. The proposed rules are also controversial because they harm investors as a class in order to confer a benefit upon a subgroup of investors. Moreover, the proposed rules are controversial because they redefine concepts at the heart of securities regulation. I briefly address each of these arguments in turn below.

First, rest assured that seeing the SEC’s climate rules as political does not mean you are a climate denier. The proposed rules do not rest upon the simple idea that the climate is changing and that human beings might have something to do with it. Rather, the proposed rules rest upon a set of strong assumptions concerning climate change. The strong assumptions underlying the proposed rule are: (1) that the climate is changing in ways that are (very) bad for human beings, (2) that human beings are largely responsible for that change, principally through GHG emissions, (3) that human beings must reduce their GHG emissions to save the climate, and finally, because this is the SEC and not the EPA, (4) that corporate financial returns are causally linked to the company’s climate policies and GHG emissions.

All of these assumptions are necessary to support the SEC’s rule. Assumptions (1) and (2) are the (partial) basis of (3). Assumption (3) supports (4), which is necessary to bring climate within the purview of SEC rule-making. However, each of these claims is subject to reasonable doubt, and as a whole, they are highly contestable. Climate change might not be (all) bad, and human beings generally and GHG emissions in particular might not the principal cause of observed changes in climate. What to do about climate change is a tradeoff question, not a scientific question, and tradeoff questions are, in their very nature, political. Finally, the extant empirical literature in no way supports a causal link between climate policy and corporate returns.

It is true that many people accept the SEC’s premises. In fact, one of our two major political parties has incorporated them into its platform. But when people accept these assumptions, they adopt a political viewpoint, not an uncontestable truth. Unfortunately for the SEC, compelling disclosures that impose a political viewpoint is anathema to the First Amendment.

My second argument for finding the proposed rules to be “controversial” is entirely independent of the first. It is that the proposed rules are controversial because they benefit a subgroup of investors—asset managers—at the expense of the investor class as a whole. Climate disclosures—greenhouse gas emissions in particular—are a boon to asset managers because they allow them to automate ESG portfolios while passing the necessary information costs onto investors generally. But the SEC does not have the authority to benefit one class of investors at the expense of others. Rather, the investor protection rationale requires the SEC to consider investor interests on a class basis—the interests of investors as such—rather than focusing on the idiosyncratic preferences of individuals or groups. Ultimately, this means focusing on financial return. Compelling the disclosure of information not relevant to financial return in order to benefit asset managers at the expense of ordinary investors is something the SEC cannot do. Or, at least, something it cannot do uncontroversially.

Third and finally, the paper argues that the proposed rules are “controversial” because they implicitly redefine concepts at the core of securities regulation, most notably “investor protection” and “materiality.” This necessarily stimulates controversy.

Because the proposed climate disclosures are controversial on the basis of one or all of these arguments, they are not subject to deferential treatment under the commercial speech doctrine. Instead, they are subject to heightened First Amendment scrutiny, a standard they cannot survive. Heightened scrutiny requires that rules be no more restrictive than necessary to achieve a legitimate governmental purpose. Even setting aside doubts concerning the legitimacy of the government’s purpose in promulgating the climate disclosures, they are manifestly more restrictive than necessary. The rules require the disclosure of immaterial information. Compelling the production of immaterial information is not necessary to protect investors. Moreover, insofar as some of the proposed rules require the disclosure of material information, these too are more extensive than necessary because companies are already required to release material information concerning climate under existing disclosure rules. The duplication of existing disclosure rules is unnecessary and therefore more restrictive than necessary. The proposed rules therefore cannot survive heightened First Amendment scrutiny.

Ultimately, the lasting contribution of the SEC’s proposal may not be the rules themselves. They are likely to be struck down. Instead, the rule’s more important contribution may be in forcing clarity concerning the constitutional scope of SEC rule-making authority. The vast majority of the SEC’s disclosure mandates, which aim only at eliciting financially relevant information, are uncontroversial and therefore deferentially reviewed under the commercial speech doctrine. However, the SEC stimulates controversy when it acts to impose a political viewpoint, to benefit a subgroup at the expense of investors generally, or to redefine concepts at the core of securities regulation. Controversy provokes heightened First Amendment scrutiny. The SEC would do well to consider its constitutional constraints before attempting to compel further ESG disclosures.

The complete paper is available for download here.