The SEC’s Climate Change Disclosure Rules are in Double Constitutional Trouble

Donald J. Kochan is a Professor of Law and the Executive Director of the Law & Economics Center at George Mason University’s Antonin Scalia Law School. This post is based on his recent piece. Related research from the Program on Corporate Governance includes The Illusory Promise of Stakeholder Governance (discussed on the Forum here) by Lucian A. Bebchuk and Roberto Tallarita; and For Whom Corporate Leaders Bargain (discussed on the Forum here) by Lucian Bebchuk, Kobi Kastiel, Roberto Tallarita; Stakeholder Capitalism in the Time of COVID (discussed on the Forum here) by Lucian Bebchuk, Kobi Kastiel, and Roberto Tallarita; Restoration: The Role Stakeholder Governance Must Play in Recreating a Fair and Sustainable American Economy—A Reply to Professor Rock (discussed on the Forum here) by Leo E. Strine, Jr.

The SEC’s climate change disclosure rules are in double constitutional trouble.  Two distinct but recently blurred administrative law doctrines loom to challenge the constitutionality of the Security and Exchange Commission’s (SEC) anticipated climate change disclosure rules.  Policymakers and courts alike should better understand the independence of these two doctrines and their capacity to defeat the SEC’s power grab.

In a March 2022 rulemaking that is still pending, the SEC proposed a set of expansive and costly regulations that would require exchange “registrants to provide certain climate-related information in their registration statements and annual reports” as well as “require information about a registrant’s climate-related risks that are reasonably likely to have a material impact on its business, results of operations, or financial condition.”  It also proposed requiring not just disclosure of a registrant’s direct, or Scope 1, greenhouse gas emissions, but also the Scope 2 greenhouse gas emissions from its purchases of electricity and investigate and report on the Scope 3 emissions of all of its partners in the supply chain.  Furthermore, “certain climate-related financial metrics” must be provided in audited financial statements if the rule is finalized as proposed.  This is an extraordinary regulatory burden designed to regulate corporate behavior regarding the environment under the guise of being “disclosure.”

The first administrative and constitutional law infirmity in the SEC’s proposed climate disclosure rule rests on an application of the “major questions doctrine,” which the U.S. Supreme Court recently gave increased recognition through its 2022 decision in West Virginia v. EPA.

Here’s the crux of the major questions doctrine and how it applies to the SEC rule.  When Congress wants to give an agency the authority to regulate on big issues – so-called “major questions” like climate change – the U.S. Supreme Court has now established that Congress must do so through a clear legislative directive.  If the language of an agency’s authorizing statute does not do so, then the agency may not presume that Congress granted broad authority over a major question.  Surely, if Congress meant to confer a power to regulate on major questions, it would have been apparent in the statutory language and not hidden.

The SEC’s mandate as detailed in its authorizing statutes is to protect the financial integrity of securities exchanges and protect investors from financial fraud.  There is no mandate to become the world’s environmental watchdog through the backdoor of regulating securities for exchange stability and investor protection.  Hence, applying the major questions doctrine, courts should hold that the SEC’s climate disclosure rules are ultra vires.

The second administrative and constitutional law infirmity derives from an application of the nondelegation doctrine.  For the SEC rules, this doctrine has received little attention.  Indeed, the inattention likely results from the emergence of a stronger major questions doctrine.  Many seem to hold a confused belief that the major questions doctrine is either the same as the nondelegation doctrine or a replacement for it.  Neither is true.  Seeing how each independently operate in a legal challenge to the expected SEC climate disclosure rule is a perfect way to correct these erroneous perceptions.

The major questions doctrine and nondelegation doctrine work as complements and in sequence.  If an agency regulation survives a major questions doctrine challenge – i.e. it is determined that Congress’s language actually did sufficiently indicate a clear intent to allow the SEC to promulgate rules that reach the major questions of climate change – we must then separately examine whether the words Congress used in doing so nonetheless unconstitutionally delegated away legislative authority to the SEC.

The major questions doctrine answers whether there was a delegation to the agency to deal with a major question.  The nondelegation doctrine tests whether when Congress did so it went too far in giving away its authority.

In other words, even if statutory language is held to indicate Congress wanted to confer authority on the SEC to use its regulatory authority to include setting climate change standards in its remit, Congress might still have unconstitutionally delegated away its authority when it did so.  To make that determination, we need to examine the language Congress used and apply the tests supplied by the nondelegation doctrine.

Article I of the U.S. Constitution provides that “All legislative Powers herein granted shall be vested in a Congress of the United States.”  Because all legislative powers are vested in the legislature, legislative powers cannot be exercised by agencies (or any other branch or entity).

As explained by the U.S. Supreme Court in its 1928 opinion in J.W. Hampton, Jr. v. United States, “If Congress shall lay down by legislative act an intelligible principle to which the person or body authorized to fix such rates is directed to conform, such legislative action is not a forbidden delegation of legislative power.”  The idea is that the intelligible principle constrains the agency from acting as a legislative body.  It shows that Congress did the legislating when it set the intelligible principle, with the agency just later filling in the gaps to effect Congress’s wishes.

A nondelegation doctrine analysis requires close analysis then of the statutory grant of rulemaking authority upon which an agency relies in promulgating rules to examine whether that grant does or does not set an intelligible principle.  In its proposed rule, the SEC claims to derive authority  principally from statutory text that, if it indeed includes climate change, means it could include anything – suggesting it lacks any limiting contours and cannot be an intelligible principle.

For example, the SEC relies on Section 7 of the Securities Act section regarding “disclosure requirements,” as authority for its climate proposal, which states that “The Commission shall adopt regulations under this subsection requiring each issuer of an asset-backed security to disclose, for each tranche or class of security, information regarding the assets backing that security.”  The Act then proceeds to prescribe the “Content of regulations,” helping us better understand Congress’s intended scope of granted authority.  The content section explains what kinds of disclosures the SEC is allowed to mandate by regulation, stating the SEC may “require issuers of asset-backed securities, at a minimum, to disclose asset-level or loan-level data, if such data are necessary for investors to independently perform due diligence, including— (i) data having unique identifiers relating to loan brokers or originators; (ii) the nature and extent of the compensation of the broker or originator of the assets backing the security; and (iii) the amount of risk retention by the originator and the securitizer of such assets.”

It is arguable that these statutory commands might set an intelligible principle if they are read narrowly, including focusing on giving the words meaning limited to what would be logical in light of the SEC’s purpose to serve as a financial watchdog that polices fraud and protects investors from unscrupulous financial practices.  But once you try expanding them to include climate change, everything falls apart.

At best, if the SEC strains credulity, it might try to claim that climate change risk could get shoehorned into “asset level . . . data, if such data are necessary for investors to independently perform due diligence” as related to “risk retention.”  Then, assume for a moment, by so claiming climate change fits these words, that the SEC is able to survive the threshold major questions doctrine inquiry – i.e. we decide that these words are broad enough to mean that Congress indeed intended to include major questions of climate change.  If that happens, then these words in the Securities Act are broad enough to drive a truck through and consequently lack any intelligible principle.  The absurdity of that conclusion buttresses a major questions doctrine challenge while also supporting a nondelegation doctrine challenge.

Similar problems exist if the SEC relies on a separate part of Section 7 of the Securities Act dealing with what the SEC may require in registration statements.  There, the Act provides that “Any such registration statement shall contain such other information, and be accompanied by 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.”  Here again, this part of the Act might or might not set an intelligible principle if cabined by the SEC’s purpose.  But it is certainly unmoored to any intelligible principle if any information on any subject matter like climate change can fit into the “in the public interest” language.

If this or any other similar sections of the Securities Act or Exchange Act that the SEC might reference indeed can include climate change, then it is difficult to see any limiting principle for determining what it would not include.  Consequently, if the language in the SEC’s authorizing legislation includes climate change, then it is hard to see how that language includes any “intelligible principle.”  And when that is absent, then an application of the nondelegation doctrine voids the grant of authority as violating the Vesting Clause of the U.S. Constitution.

Admittedly, across decades of tolerance for a growing administrative state, the nondelegation doctrine has not been applied to invalidate an agency rule since the 1930s.  But it has never been killed in the courts either.  Further, several justices on the U.S. Supreme Court have hinted at the need to revive it as a more robust constitutional test.  Thus, the climate is ripe for finding good cases to which it can be applied, and the SEC’s climate disclosure rules might be just the right fit.  And, these infirm rules would be a great vehicle for describing how these two doctrines – major questions and nondelegation – work together.

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