Will Stakeholder Objections and Legal Uncertainty Slow an ESG Revolution?

This is the sixth part in our 2023 series examining important trends in white collar law and investigations. Up next: MA attorney general.

According to the Securities & Exchange Commission, its proposed revisions to SEC regulations regarding climate change disclosures in May 2022 were intended to provide investors with consistent and reliable information regarding how climate change could impact their investment decisions. We have written previously about how these disclosure requirements affect investment advisers and about some of the key takeaways from climate-related disclosures under the new rule.

Many stakeholders and market participants have come out strongly against certain aspects of the proposed rules. We will revisit here the key points of the SEC’s proposed rules (focusing on those drawing the most criticism), summarize the pushback the proposed rules have received, and consider where the SEC may go from here.

Revisiting Key Aspects of the SEC Proposal

In 2010, the SEC first adopted guidance describing how existing rules could require companies to disclose how climate change could impact their businesses. Specifically, the guidance focused on areas where climate change could trigger disclosure—the impact of climate change regulation and legislation on business, the impact of international accords, the indirect consequences of regulation or business trends, and the physical impacts of climate change. In short, the guidance directed companies to disclose ESG-related information based on whether such information was material as described in TSC Industries v. Northway (holding that a “fact is material if there is a substantial likelihood that a reasonable shareholder would consider it important in deciding how to vote”).

Last year, the SEC proposed new rules that would enhance climate-related disclosures for businesses. Should the new provisions go into effect, companies would be required to report climate-related risks that amount to 1% or higher of a total line item in a company’s financial statements. As outlined in a press release, the provisions would also require registrants  to disclose information about direct greenhouse gas (GHG) emissions and indirect emissions from purchased electricity as well as GHG emissions from upstream and downstream activities in its value chain if material or if the registrant has set a GHG emissions target. The proposal was open for public comment for 90 days following its proposal—originally ending in June 2022 but reopened until Nov. 1, 2022 after a technical issue impacted online comment submissions. In total, the SEC received more than 14,000 comments in response to the rule.

The Opposition

Companies have called on the SEC to reconsider its approach, citing the practical difficulties that would result from the proposal. Amazon.com Inc. noted that companies would need to essentially double their accounting efforts if the SEC required them to disclose lost revenues and avoided costs because of climate-related factors. Institutional investors, such as BlackRock, have commented that the 1% rule “would result in highly inaccurate disclosures and unduly burdensome compliance costs.”

Commissioner Hester Peirce has also criticized the proposed rules as unnecessary in light of existing rules requiring companies to disclose material risks. According to Commissioner Peirce, “rather than simply ticking off a preset checklist based on regulators’ prognostication of what should matter, companies have to think about what is financially material in their unique circumstances” under those rules. As Bloomberg has noted, some companies object to the GHG reporting on the basis that they need “more flexibility” to reflect climate-related risks than such rules would allow.

Commissioner Mark T. Uyeda has suggested that the SEC’s usual “straightforward regulatory approach would treat ESG [a shorthand for Environmental, Social, and Governance issues] investing like any other investment strategy” and so makes ESG-specific regulations superfluous. In short, the SEC can bring enforcement actions against companies that fail to invest in a manner described to clients. Even without finalized rules, the SEC has brough ESG-related enforcement actions. For example, it charged BNY Mellon Investment Adviser, Inc. for representing that all investments in specific mutual funds had undergone ESG-quality review when several did not. The SEC also charged Vale S.A., a publicly-traded Brazilian mining company, for misleading investors and governments through its ESG disclosures regarding the safety of a dam it had constructed.

Beyond the fact that the SEC may already use its regulatory framework to pursue ESG-related fraud, Commissioner Uyeda described three problems with ESG-specific regulations. First, an objective definition of ESG is illusive and thus fails to provide standardized metrics for investors. Second, the SEC may be (undemocratically) putting a thumb on the scale in favor of certain ESG objectives. And third, asset managers may be pursuing ESG objectives without receiving such a mandate from their clients.

The Rationale

The SEC is considering “softening” rules mandating companies’ disclosure of the effects of climate change on its business in face of such opposition. So why might the SEC consider changing its climate change proposal?

First, as a matter of expedience, the SEC might alter its rules to demonstrate its own flexibility and to show that it’s listening, bolstering its chance of success in any court challenge once the final rules are adopted. Courts, such as the D.C. Circuit Court of Appeals in Carlson v. Postal Regulatory Com’n, have noted that reasoned decision-making includes an agency’s response to public comments challenging its proposed rules. And the SEC may recognize that it could still achieve the majority of its climate change disclosure goals notwithstanding revisions around the edges of its proposal. Alex Martin, a senior policy climate analyst for Americans for Financial Reform has asserted that SEC could forego the 1% threshold rule and still achieve the majority of its disclosure goals where “other proposed changes to companies’ financial statements are more important, such as a requirement that companies to disclose the assumptions they use to make forward-looking estimates regarding, for instance, the profitability of fossil-fuel assets.”

Second, the SEC must have in mind recent successful legal challenges to agency authority.  For example, in NFIB v. OSHA, the National Federation of Independent Business (NFIB) challenged OSHA’s promulgated rule requiring employers with at least 100 employees to require workers to receive the COVID-19 vaccine or wear a mask and be subject to weekly testing. The Supreme Court stayed OSHA’s vaccine mandate on the basis that the challengers were likely to prevail because the agency had exceeded its statutory authority. The Court noted that Congress had created OSHA to set workplace safety standards and that the rule at issue went beyond such authorization to essentially create “broad public health measures.”

West Virginia v. EPA placed another limit on agency authority. West Virginia and other states challenged the EPA’s authority to broadly regulate GHG emissions via the Clean Power Plan (repealed by the Trump administration which had its replacement, the Affordable Clean Energy Rule, vacated by the D.C. Circuit). The Supreme Court held that the EPA did not have the requisite authority to regulate GHG emissions under a generation shifting approach as outlined in the Clean Power Plan. The West Virginia Court made plain that because the EPA “assert[ed] highly consequential power beyond what Congress could reasonably be understood to have granted,” the agency needs clear congressional authorization to cap carbon emissions as outlined in the Clean Power Plan.

Given the Supreme Court’s willingness to circumscribe an agency’s authority to regulate beyond its mandate, the SEC may take a more cautious approach to avoid serious challenges that could result in courts curtailing the agency’s authority.

Final Thoughts

The fate of the SEC’s proposed rules on climate change disclosures remains unclear. Given the nature and amount of pushback the SEC has received, and the current legal environment of hostility to agency action that strays beyond the bounds of clearly proscribed authority from Congress, it seems likely the SEC may soften its proposals in the near future.

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