The SEC’s Authority to Pursue Climate-Related Disclosure

Jill E. Fisch is the Saul A. Fox Distinguished Professor of Business Law and co-Director of the Institute for Law and Economics at the University of Pennsylvania Carey Law School. This post is based on a comment letter to the U.S. Securities and Exchange Commission by Prof. Fisch; George S. Georgiev, Associate Professor of Law at Emory University School of Law; Donna M. Nagy, C. Ben Dutton Professor of Business Law at Indiana University Maurer School of Law; and Cynthia A. Williams, Visiting Professor of Law at Indiana University Maurer School of Law and Professor of Law Emerita at the University of Illinois College of Law.

On behalf of the 30 undersigned law professors, all of whom teach and write on U.S. securities law and capital markets regulation, we welcome the opportunity to provide our views on the Commission’s recent proposal related to the enhancement and standardization of climate-related disclosures for investors (the “Proposal”). We focus on a single question—whether the Proposal is within the Commission’s rulemaking authority—and we unanimously answer this question in the affirmative. We base this conclusion on the analysis set out below. We do not all agree on the policy issues facing the Commission with respect to the optimal scope of environmental, social and governance (ESG) disclosure, including climate-related disclosure. But we all share the view that the Commission has ample, longstanding, and clear authority to promulgate disclosure rules in this area.

1. The Plain Text, Legislative History, and Judicial Interpretation of the Securities Laws Support the Commission’s Authority to Mandate Climate-Related Disclosures

The federal securities laws establish the Commission as the primary regulator of the capital markets, and Congress instructed the Commission, through those laws, to regulate the markets through an extensive disclosure regime for publicly traded companies. The Commission’s statutory authority over disclosure is broad. In 2018, then-Chairman Jay Clayton described the Commission’s disclosure system as “powerful, far reaching, dynamic and ever evolving” and noted that “[a]s stewards of this . . . system, a key responsibility of the SEC is to ensure that the mix of information companies provide to investors facilitates well-informed decision making.”

Congress, in the original federal securities laws, the Securities Act of 1933 and the Securities Exchange Act of 1934, authorized the Commission to promulgate rules for registrant disclosure pursuant to broadly articulated delegations of authority. For example, Section 7 of the Securities Act identified categories of information required to be included in the registration statement for public offerings, as augmented by “such other information . . . as the Commission may by rules or regulation require as being necessary or appropriate in the public interest or for the protection of investors.” Section 12 of the Exchange Act conditions trading on exchanges on disclosing “such information, in such detail, as to the [company] . . . as the Commission may by rules and regulations require, as necessary or appropriate in the public interest or for the protection of investors, in respect of the following: . . . the organization, financial structure, and nature of the business.” Section 13(a)(2) of the Exchange Act, which establishes the periodic reporting framework for public companies, requires companies to disclose information under rules the Commission “may prescribe as necessary or appropriate for the proper protection of investors and to insure fair dealing in the security . . . such annual reports . . . and such quarterly reports . . . as the Commission may prescribe.” Section 3(b) of the Exchange Act adds Commission authority to “define technical, trade, accounting, and other terms used [in the statute].” These are only some examples of Congress’ broad delegation to the Commission of the power to determine what disclosure is necessary or appropriate in the public interest, or for the protection of investors, or to promote fair dealing in securities traded on the U.S. capital markets.

Moreover, Congress recognized that capital market regulation was essential, not just for investor protection, but to serve the broader interests of the U.S. economy. As a result, in 1996, Congress instructed the Commission in determining whether a disclosure requirement is necessary or appropriate to consider “whether the action will promote efficiency, competition, and capital formation.” This language reflects well-settled understanding that public company securities trade in efficient markets and that the prices of those securities incorporate relevant and accurate information generated through the Commission’s disclosure requirements and guaranteed through its liability regime. This regulatory scheme serves to protect investors, improve market efficiency, and ensure the productive allocation of capital.

We further note that the Commission’s disclosure authority extends not just to information relevant to investor trading decisions but also to information used by investors in connection with the exercise of their voting power. The Commission’s broad authority to regulate the proxy voting process, found in Section 14(a) of the Exchange Act, requires proxy solicitations to be conducted in accordance with “such rules and regulations as the Commission may prescribe as necessary or appropriate in the public interest or for the protection of investors.” Shareholder voting on issues ranging from the election of directors to the approval of mergers is a critical governance tool, and the Commission’s disclosure requirements enable shareholders to exercise that voting power on an informed basis.

Courts have always interpreted the authorization to act as “necessary or appropriate in the public interest or for the protection of investors” as granting the Commission broad rulemaking authority. As summarized by the D.C. Circuit Court of Appeals in 1979, “the Commission has been vested by Congress with broad discretionary powers to promulgate (or not to promulgate) rules requiring disclosure of information beyond that specifically required by statute.” We note that no court has invalidated a Commission rule for overstepping the Commission’s disclosure authority despite the Commission’s active rulemaking spanning close to nine decades and despite the fact that, as is often the case with economic regulation, many of the Commission’s rules were initially resisted by the regulated entities and other interested parties.

Even a narrow reading of the legislative history of the original securities laws supports the Commission’s authority to pursue the Proposal because climate-related matters impact the most important aspect of any securities transaction—the price at which investors buy or sell—and Congress was focused on valuation matters, among others, when it adopted the Securities Act in 1933. Congress’ intent was to create an information-generating regime “designed to reach items of distribution profits, watered values, and hidden interests . . . [of] indispensable importance in appraising the soundness of a security,” which contains “items indispensable to any accurate judgment upon the value of the security.”

It is important to consider the Proposal within the established legal context described above. The Commission’s proposal requires that issuers disclose climate-related information relevant to their business operations. This information includes, inter alia, qualitative disclosures about the issuer’s climate-related governance, risks and strategy, quantitative disclosure of Scopes 1 and 2 greenhouse gas emissions, and, if (and only if) an issuer has already elected to adopt transition plans or set targets, a summary of those. Notably, the Proposal does not mandate any operational changes with respect to climate. It does not require issuers to adopt particular governance structures to oversee climate risk, it does not require issuers to set carbon goals, and it does not demand that issuers implement a climate transition plan. Instead, it provides a standardized disclosure framework that allows investors and markets to value firms by ensuring that they can price in various factors, including climate-related risks, climate-related trends and uncertainties, and climate-related business opportunities.

Without standardization, investors lack the ability to assess the risk of greenwashing and other practices meant to conceal and confuse regarding these risks, trends, uncertainties, and opportunities. There is extensive evidence that markets currently do not have sufficient information to price climate-related risk accurately, even though climate-related matters may lead to significant write-downs. The Proposal therefore meets the need for a credibility-enhancing platform for issuers, from which investor expectations of honesty and fair dealing will follow. This is a considerable step forward from the current regulatory setting, which has led to confusing variations in what, if anything, is said about key environmental risks in both the short term and the long term, and which has made what little enforcement there is a matter of interpreting forward-looking regulatory mandates by “facts and circumstances” invocations of fraudulent concealment or the half-truth doctrine.

The Proposal’s requirements are thus properly understood as core capital markets disclosure in the service of the statutory goals discussed above. Providing investors with the appropriate level of information, eliciting higher-quality information about risks and opportunities, and standardizing what is currently an uncoordinated universe of ESG disclosures increases confidence in the capital markets and bolsters investors’ willingness to supply capital by reducing knowledge gaps and asymmetries. The information provides value both to retail investors, who are important as suppliers of longer-term capital, as well as institutional intermediaries who are tasked with evaluating the ESG characteristics of portfolio companies in order to convey those characteristics accurately to their customers. Climate-related disclosures would also reflect the business impacts of ongoing changes to the global regulatory landscape. Irrespective of one’s views on these changes, most of them lie outside the control of U.S. regulators but still affect U.S. firms and their investors due to the design of our time-tested free market system. In light of these dynamics, it falls on the federal securities disclosure regime to facilitate the efficient allocation of capital and to promote capital formation by enabling investors to assess how companies will fare when faced with new challenges and new opportunities. As such, the Proposal fits within core SEC authority by giving investors insight into the amount and timing of cash flows that might be affected by climate or transition risks and allowing investors to evaluate companies’ going concern value.

Finally, there is a related yet distinct point having to do with the promotion of competition, which has been part of the statutory framework since 1996. Sustainable finance has become a significant phenomenon in U.S. capital markets in recent years, which includes strong capital inflows into sustainable funds. Scholars disagree about the desirability of these developments. Regardless of one’s normative stance, however, it is an uncontroversial proposition that competition for investor capital should not be based on misleading or incomplete information. And yet, ESG information today lacks consistency, comparability, and reliability despite the large pools of capital at stake. Consequently, sustainable firms are unable to differentiate themselves from, and compete with, less sustainable firms. Separately, asset managers cannot effectively compete with one another to assemble high-performing funds, including but not limited to sustainability-focused funds, that meet investor preferences. When investors and asset managers rely on incomplete and low-quality data, often coming from third-party providers, this has distortive effects on competition, market efficiency, capital formation, and the overall integrity of U.S. capital markets. These problems fall squarely within the Commission’s rulemaking authority, which justifies the Commission’s present effort to address them through the Proposal on climate-related disclosure.

2. The Statutory Framework Requires the Commission to Adjust and Update the Content of the Disclosure Regime in Response to the Evolution of the Economy and Markets

The Commission’s integrated disclosure regime as it exists today traces its origins directly to Schedule A of the Securities Act of 1933, which has never been amended or repealed by Congress. Schedule A represents a detailed initial template: it prescribes 32 categories of information, both general and highly specific, that are required to be included in Commission-filed registration statements. Congress delegated power to the Commission to waive some of the requirements of Schedule A, and, importantly, to mandate disclosure of “such other information, and . . . such other documents, as the Commission may by rules or regulations require as being necessary or appropriate in the public interest or for the protection of investors.” The Commission has mandated such disclosures on a wide variety of topics over the course of its 88-year history, without challenge to its authority. The Commission has consistently exercised its delegated authority to adjust the disclosure regime—both by adding to and subtracting from the initial topics Congress put forward in 1933—to account for the evolution of the economy and financial markets.

Regulation S-K, which is currently used for the preparation of not only Commission-filed registration statements but also for registrants’ annual and quarterly reports, can be traced back directly to Schedule A. Regulation S-X, which contains disclosure requirements for information presented in financial statements, contains many highly detailed disclosure rubrics and checklists, which have been promulgated through iterative amendments in consultation with investors.

Because Schedule A reflects Congress’ initial template for the disclosure regime, its design is instructive on three points that are relevant to climate-related disclosure rulemaking. First, even though Congress was aware of the concept of materiality, it did not impose a materiality constraint, either for Schedule A as a whole, or for the type of “other information” the Commission is expressly authorized to require. Second, Congress deemed it appropriate to require disclosure of information about specific contracts and remuneration arrangements involving amounts that were not financially significant when viewed in isolation. Third, Congress calibrated Schedule A to the particular risks of the time and was not deterred from requiring disclosure simply because a problem was not exclusively an investor protection problem or because it had high public salience.

Relying on its delegated power, the Commission has in Regulations S-K and S-X built out a detailed disclosure regime aimed at protecting investors and the capital markets. As the economy and financial markets have grown in size and complexity, the Commission has continuously updated the disclosure framework. This process of iterative modernization has included the scaling back of certain disclosure requirements. For the same reasons, the Commission has also expanded the disclosure regime to cover a number of matters that are not expressly addressed 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. During the tenure of Chairman Jay Clayton, the Commission recognized that economic changes warrant a specific disclosure requirement in the area of human capital management (HCM), and it adopted this new disclosure provision without a Congressional mandate.

In addition to formal disclosure rules, the Commission has also developed a practice of providing real-time disclosure guidance for the benefit of investors and registrants, which in most cases results in substantially enhanced disclosure. For example, the Commission has provided detailed guidance on disclosure relating to “Year 2000” (Y2K) risks, the impact of the Eurozone crisis and Brexit, and, most recently, the Covid-19 pandemic and Russia’s war on Ukraine. The Commission’s disclosure policies have responded to market developments, and at no time has Congress legislatively overridden these new or enhanced disclosure requirements.

It should be emphasized that if Congress had objected to the Commission’s approach, it could have easily intervened. Congress has amended the Securities Act and the Exchange Act on multiple occasions since the 1930s, so it has had ample opportunity to reconsider the broad authority it delegated for disclosure-based rules, or to constrain the Commission’s power to require disclosures about new topics. It has not found it necessary to do so. As the D.C. Circuit has explained, “[r]ather than casting disclosure rules in stone, [the 1933] Congress opted to rely on the discretion and expertise of the SEC for a determination of what types of additional disclosure would be desirable.” The court further noted that “[t]he Commission’s task [is] a peculiarly difficult one, requiring it to find a path between the views of the parties to the rulemaking polarized in support of the broadest disclosure or in opposition to any disclosure, to interpret novel statutory commands, and to make decisions against the background of rapidly changing conditions.” Indeed, Congress delegated the task of keeping up with the rapid evolution of financial markets and of regulating those markets to a specialized agency—the Commission—precisely because the task at hand is a “difficult one.”

The significance of climate-related information to the capital markets and participants in those markets highlights the distinctive role for the Commission in overseeing this disclosure. This role is not diminished by the existence of a multitude of administrative agencies that also have the power to issue disclosure requirements. For example, the Internal Revenue Service requires companies to disclose information about their financial condition including their profits and expenses, the Occupational Safety and Health Administration requires employers to disclose information about workplace safety, the Equal Employment Opportunity Commission requires disclosure of workforce demographic data, and the Environmental Protection Agency requires companies to disclose information about their environmental impact. In many cases these disclosures cover similar subject matter to that required in securities filings, but as these examples illustrate, the disclosures are directed to different audiences and serve different regulatory goals.

Nor is the Commission’s disclosure authority in some way constrained because of its limited technical expertise with respect to climate-related matters. The Commission has decades-long experience handling disclosures on technical topics. Moreover, as in other areas, the Commission’s Proposal draws upon the technical expertise of outside experts. The history of drawing upon outside expertise to formulate capital market disclosure requirements dates back to the 1930s when the Commission, rather than developing a set of internal metrics for financial disclosure, drew upon the technical framework established by FASB’s predecessors. Similarly, although the Commission is not an energy regulator, 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. As the composition of the economy has changed, the Commission has had to develop some expertise in cybersecurity disclosure, tech disclosure, and in other specialized areas. Similarly here, the Commission’s proposal draws on technical frameworks for financially material disclosure developed by expert groups such as the Task Force on Climate-Related Financial Disclosures (TCFD) and the Greenhouse Gas Protocol. In line with the Commission’s historical approach, the Proposal simply requires disclosure and does not seek to establish substantive operational requirements: The Commission is not setting GHG emission limits, calculating carbon trading prices, drawing up climate transition plans, or setting climate resilience standards for businesses. The Commission is cognizant of the appropriate role of disclosure as a regulatory tool and it is not aiming to address climate change any more than it was trying to solve a geopolitical crisis (Russia’s war on Ukraine) or a global health crisis (the Covid-19 pandemic) when it required public companies, for the benefit of investors and markets, to disclose the risks and operational and financial impacts of these critical events.

To be sure, mandatory disclosure by public companies can also be relevant to stakeholders beyond direct investors. An issuer’s financial condition is relevant to its customers, its suppliers, and its employees. Investors in one issuer may glean valuable insight from examining the securities disclosures of its peers, while investors in the private markets may benefit from the information released by public companies. Mandated disclosure has always resulted in positive externalities. Cybersecurity information is of interest to customers (in addition to investors), information about the unfolding Covid-19 pandemic was of interest to employees (in addition to investors), and so on. But this Proposal stands solidly on investor and marketplace protection and any collateral benefits for other stakeholders would be a bonus for the public interest. Indeed, during the Covid-19 crisis, the Republican-appointed leadership of the Commission spoke approvingly of the collateral benefits of investor-facing disclosure for society.

3. The Proposal is Consistent with the Commission’s Exercise of Its Statutory Authority in the Area of Environmental and Climate-Related Disclosure for Over 50 Years

The Proposal does not take the capital market disclosure regime into uncharted territory because the Commission has focused on environmental issues facing businesses for over five decades. Importantly, market and business developments have, over time, changed both the importance of environmental disclosures and the practicality of requiring those disclosures. When the Commission first considered petitions for specialized environmental disclosure in 1975, it found that there was “no uniform method by which the environmental effects of corporate practices [could] be described.” In the past 47 years, the market has developed widely accepted frameworks for describing those effects, largely in response to investor demands for such information and largely through the concerted efforts of mainstream investors. Similarly, shareholder proposals seeking environmental disclosures receive unprecedented levels of support, particularly recently, either through a formal vote, or by way of a settlement.

In line with its “dynamic and ever evolving” approach to disclosure discussed above, and as environmental and climate issues have grown in complexity and magnitude over time (due to economic growth, globalization, substantive regulation, and the ever-changing nature of economic activity), the Commission has periodically updated its rules and provided registrants with additional guidance. The following overview highlights just some of the Commission’s extensive work in this area.

The Commission’s long history of requiring environmental disclosures dates back to the Nixon Administration when, in a 1971 release, the Commission “called attention to the requirements” under the Securities Act and the Exchange Act “for disclosure of legal proceedings and a description of the registrant’s business as these requirements relate to material matters involving the environment and civil rights.” In 1973, the Commission mandated disclosure of all environmental proceedings by a governmental authority, and of environmental proceedings not involving a governmental authority that meet certain specified conditions, and in 1976 the Commission required disclosure about capital expenditures relating to environmental compliance. The Commission continued to recalibrate its disclosure requirements with respect to environmental information over time and made adjustments to Regulation S-K in 1981 and 1982. In parallel, the Commission and accounting standard-setters developed detailed rules on the treatment of contingent environmental liabilities, as well as rules about disclosure and accrual of environmental obligations upon future asset retirement. The Commission’s MD&A releases have also made reference to environmental matters. Of particular note, in 1993 the Commission issued Staff Accounting Bulletin 92, which addressed accounting and disclosures relating to environmental loss contingencies. The existence of extensive financial disclosure rules and guidance related to environmental matters has been overlooked as part of efforts to portray the Commission’s Proposal as unprecedented.

More recently, in 2010, the Commission provided additional guidance on climate-change developments that could be required to be disclosed under Commission rules. Noting that legislation, regulation, international accords, business trends, and physical impacts of climate change could all affect a registrant’s operations or results, the guidance “remind[ed] companies of their obligations under existing federal securities laws” as well as “to consider climate change and its consequences as they prepare documents to be filed with us and provided to investors.” The Commission grounded this requirement in several existing provisions of Regulation S-K, including the MD&A (Item 303), the required disclosure of legal proceedings (Item 103), and the section on risk factors (Items 105 and 503).

Notably, no one in 2010 argued that the Commission lacked authority to mandate climate-related disclosure, or that climate change was a novel (or, even less plausibly, illegitimate) subject matter for the disclosure regime. A contemporaneous analysis of the Commission’s 2010 guidance and of critics’ reactions published by one prominent corporate law scholar concluded that “the requirement that firms discuss climate change is not new,” that “[a]ffected corporations already know that they need to provide climate change-related disclosure,” that “[c]orporate lawyers already know how to write such disclosures,” and that “claims that these disclosures will be ‘silly’ or will produce a ‘massive subsidy to charlatans’ are overstated.” These observations from 2010 are equally valid with respect to the Commission’s 2022 Proposal.

In summary, the Commission’s long history of requiring registrants to include environmental disclosures in their filings refutes claims that the current Proposal constitutes a “drastic change in authority” and “is outside of its historical purview.” To the contrary, the Proposal reflects regulatory power that the Commission has exercised consistently—and without legislative override—since the 1930s with regard to disclosure generally and since the 1970s for environmental disclosures. Moreover, while the Proposal applies to capital market participants, as does all disclosure, it can hardly be said to involve major questions about regulating the economy in the command-and-control sense in which the Supreme Court has spoken about regulation.

4. The Federal Securities Laws Do Not Impose a Materiality Constraint on the Commission’s Authority to Promulgate Climate-Related Disclosure Requirements

The role of materiality in Commission disclosure rulemaking is complex and often misunderstood. As a foundational matter, we emphasize that nothing in the federal securities statutes or in judicial precedent, including Supreme Court precedent, imposes a materiality constraint on Commission rulemaking, or requires the Commission to incorporate materiality qualifiers in the language of specific disclosure rules.

Debates about ESG disclosure rules often reference the Supreme Court’s classic articulation of materiality in TSC Industries v. Northway and Basic v. Levinson. A crucial first step in understanding these cases is that they deal with whether or not an issuer, at some specified point in the past, had a legal duty to disclose particular information, under a particular set of circumstances and in light of the applicable regulatory framework. In other words, the Supreme Court’s materiality test applies to an ex post liability determination by a court or another adjudicatory body, not to an ex ante policy choice by a regulator. In stark contrast, when it engages in disclosure rulemaking, the Commission is making ex ante policy choices. Unsurprisingly, then, neither TSC Industries, nor Basic, nor any other Supreme Court case touches on or limits the types of information the Commission is empowered to require when it promulgates disclosure rules.

The existing confusion on this point is understandable, at least to a certain degree. Materiality is a complex concept that fulfills several different functions in securities law. The Commission has referenced the Supreme Court’s succinct articulation of materiality with some frequency for the sake of consistency, and many existing disclosure requirements expressly incorporate a materiality test. Notably, even in these cases, however, the Commission has not left firms to struggle with the Supreme Court’s elegant-yet-economical articulation of materiality. Instead, the Commission has supplied extensive guidance on how firms are to go about making the often-difficult materiality judgments. Over the years, some of this guidance has been general in character, and some of it has been more topic-specific. Notably, a subset of existing disclosure items are not qualified by materiality, reflecting a policy judgment—and, we emphasize, a judgment the Commission has always been free to make—that particularized materiality testing at the disclosure stage is unwarranted because, for example, it may be impractical or costly for registrants, because it may be susceptible to abuse, or because the underlying information is basic in nature.

It is instructive that none of the hundreds of disclosure rules the Commission has promulgated since the 1930s has been challenged in court on materiality grounds; this corpus includes many rules adopted pursuant to the Commission’s broad delegated authority (rather than prescriptive Congressional mandates), as well as various rules on environmental and climate matters. When the D.C. Circuit has struck down Commission rules, it has been for reasons such as failure to carry out adequate cost-benefit analysis, and never due to a finding that the challenged rule lacked materiality. Importantly, the D.C. Circuit has refused to link the cost-benefit analysis requirement to an assessment of materiality. The closest the D.C. Circuit has come to considering materiality in the context of Commission disclosure rulemaking has been to suggest that the Commission is entitled to deference in its determination on the materiality (or lack thereof) of particular topics.

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Based on the analysis presented in this post, it is our view that the Commission’s Proposal contemplates disclosure requirements that are consistent with close to nine decades of regulatory practice at the federal level and with statutory authority dating back to 1933 that has been repeatedly reaffirmed by Congress and the courts. Accordingly, we are unanimous in our conclusion that the Commission has the statutory authority to promulgate climate-related disclosure rules of the kind currently under consideration. We appreciate the opportunity to submit these comments and would be happy to discuss any of the points raised herein at your convenience.

The complete publication, including footnotes, is available here.

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