In a recent post, we summarized comments submitted to the Securities and Exchange Commission (SEC or Commission) regarding the request for public input on climate change disclosures (RFPI) released by then Acting Chair, Allison Herren Lee on March 15, 2021.
With the Commission set to release a Notice of Proposed Rulemaking on climate disclosure by the end of the year, we must now consider how any new rules may best survive legal challenges, and a central component to any challenge is likely to be that the Commission failed to fulfill its obligations under the Administrative Procedure Act to perform a thorough cost-benefit analysis (CBA). Assessing the relevant costs and benefits associated with any new mandatory climate disclosure rule will likely pose a significant challenge for the Commission. Below, we offer some suggestions as to how the Commission might best proceed with this critical task.
Some History
President Clinton signed Executive Order 12866 (EO 12866) on September 30, 1993. The EO 12866 requires any significant regulatory action by a federal agency to first be submitted for review to the Office of Information and Regulatory Affairs (OIRA) within the Office of Management and Budget (OMB). The submission must include a “description of the need for the regulatory action as well as an “assessment of the potential costs and benefit of the regulatory action.”
As an independent agency, the SEC is exempt from EO 12866, but this has not stopped the Commission from conducting its own CBA on proposed rules. In fact, as the DC Circuit has made clear, the SEC cannot reach a conclusion that is “unsupported by substantial evidence” or “arbitrary [and] capricious.” The Administrative Procedure Act (APA) looms large over the SEC, and as a result of the pressures to prove its actions well-founded, the SEC has voluntarily included CBA in proposed rules dating back to the 1970s.
The SEC’s CBA process changed in 1996 when Congress passed the National Securities Markets Improvement Act, which required the Commission to consider “efficiency, competition, and capital formation” (ECCF) in its rulemakings. Congress, the SEC, and courts have struggled to articulate what ECCF means under the construct of the Administrative Procedure Act. Two of the more notable legal cases are Chamber of Commerce v. SEC and Business Roundtable v. SEC.
In 2005’s Chamber of Commerce v. SEC, the D.C. Circuit held that it was “acutely aware that an agency need not—indeed cannot—base its every action upon empirical data; depending upon the nature of the problem, an agency may be entitled to conduct … a general analysis based on informed conjecture.”[1] Nonetheless, the Court struck down the rule in question after finding the Commission failed to estimate a specific cost even though the Commission confessed to having “no reliable basis for estimating those costs.” The Court’s decision imposed an obligation on the Commission to make quantitative estimates even “in [the] face of uncertainty…” The Court also cited the Commission’s failure to take account of alternative proposals put forth by two dissenting SEC Commissioners: “We conclude the Commission’s failure to consider the disclosure alternative violated the APA.” The Court’s emphasis on the views of dissenting Commissioners may augur problems for a new climate-disclosure rule.
In 2011’s Business Roundtable v. SEC, the D.C. Circuit vacated the SEC rule on proxy access proposals, reasoning that the Commission failed to “adequately to assess the economic consequences” and thus acted capriciously and arbitrarily.[2] The Court criticized the Commission’s CBA, finding that it “relied upon insufficient empirical data” when it concluded the rule would “improve board performance and increase shareholder value by facilitating election of dissident shareholder nominees.”[3] The Court held that evidence cited by the SEC in its CBA—including a large volume of studies showing that increasing accountability of the board increases shareholder value—is “admittedly (and at best) ‘mixed’ empirical evidence.”[4] Some scholars suggested that the Court effectively created a new burden of proof by requiring the Commission to convince the Court itself of the relative merits of a new rule.
Business Roundtable Aftermath
Following Business Roundtable, the SEC reformed their CBA process, also known as economic analysis.[5] These reforms were set forth in a 2012 staff memo titled: “Current Guidance on Economic Analysis in SEC Rulemakings” (2012 Guidance). The 2012 Guidance largely follows EO 12866 and notes the “basic elements of a good regulatory economic analysis” include:
- a statement of the need for the proposed action;
- the definition of a baseline against which to measure the likely economic consequences of the proposed regulation;
- the identification of alternative regulatory approaches; and
- an evaluation of the benefits and costs—both quantitative and qualitative—of the proposed action and the main alternatives identified by the analysis.
Below we offer suggestions for how the Commission may approach each of these elements when evaluating climate risk disclosure rules.
Need for the proposed action
This component is relatively straightforward and easy to meet when it comes to a climate disclosure rule. As Commissioner Lee stated in her public statement inviting comment on climate change disclosures:
“Since 2010, investor demand for, and company disclosure of information about, climate change risks, impacts, and opportunities has grown dramatically. Consequently, questions arise about whether climate change disclosures adequately inform investors about known material risks, uncertainties, impacts, and opportunities, and whether greater consistency could be achieved.”
Investors and other market participants (e.g., lenders, suppliers, executives, index providers, rating agencies, competitors, customers, and others) increasingly want to know companies’ climate-related risks and opportunities. These market participants, acting individually and collectively, play significant roles in the SEC’s efforts to ensure markets are “fair, orderly, and efficient.” Today, these stakeholders look to public company filings, but are often unable to identify and meaningfully assess climate-related risks and opportunities.
Perhaps the greatest demand for climate-related disclosures is coming directly from investors. A Davis Polk analysis found that nearly 23 percent of all comments for the RFPI came from asset/managers/investors/investor groups. As indicated in our recent summary, a majority of these commenters are supportive of mandatory climate disclosures. Similarly, according to a survey by the Principles for Responsible Investment (PRI), over 87.5 percent of PRI signatories “want the SEC to establish a mandatory baseline issuer ESG disclosure to quickly provide the consistent, comparable data necessary to fully consider ESG-related risks and opportunities in investment decisions.” And in a recent speech, SEC Chairman Gary Gensler reiterated that “large and small investors” are looking for climate risk information “to determine whether to invest, sell, or make a voting decision one way or another.”
The 2012 Guidance notes that a proposed rule may be a “response to a market failure that market participants cannot solve because of collective action problems.” While climate change is clearly a collective action problem, so too is the lack of reliable, consistent, and comparable climate risk disclosure from companies (public and private). Absent a regulatory mandate, several third-party voluntary standards have emerged, which has led, as Chairman Gensler acknowledged, “to a wide range of inconsistent disclosures.” Several market participants commented to the RFPI noting their significant efforts to obtain the information they need from companies to make informed business decisions. This information is essential for “fair, orderly, and efficient” markets.
When markets fail to supply information that investors and other market participants need in order to make informed business decisions, the SEC has historically stepped in—in fact, it is the reason for the federal securities laws. When passing the Securities Act of 1933, Congress expressly declared:
“Whatever may be the full catalogue of the forces that brought to pass the present depression, not least among these has been this wanton misdirection of the capital resources of the Nation … The bill closes the channels of such commerce to security issuers unless and until a full disclosure of the character of such securities has been made.”[6]
Since 1933, the “full disclosure of the character of such securities” has evolved. Investors, lenders, customers, and other market participants know a lot more. Many issues that were once viewed as immaterial or “non-financial” are now anything but. In a March 2021 speech, the SEC’s acting director for the Division of Corporate Finance, John Coates, offered up asbestos-related disclosure as an analogy to changing perceptions around climate risks:
“For years, asbestos-related risks were invisible, and information about asbestos would likely have been called ‘non-financial.’”
Is there any doubt, after a summer of extreme weather events throughout the world, that climate change is a financial risk?
Defining the Baselines
The 2012 Guidance acknowledges that costs and benefits can only be quantified by comparison to “how the world would look in the absence of the proposed action.” This “baseline” must include an assessment of “the existing state of efficiency, competition, and capital formation” in the relevant market. The SEC’s baselines should cover the current practices, costs, and benefits of all market participants, including the would-be disclosing parties, as well as the other market participants who are impacted by climate-related risks and opportunities.
If the baseline assessment reveals that relatively few public firms report information on climate risks, then the costs to registrants of being forced to disclose such information may be substantial. Therefore, the SEC should seek to identify what firms are currently disclosing, how detailed these disclosures are, where they are being made, to whom they are being made, and in what form they are being made.
Fortunately, some of this work has already been done by NGOs and third-party standard setters. A 2020 report from the Governance Accountability Institute found that 65 percent of companies in the Russell 1000 Index, and 90 percent of the 500 largest companies in that index, published sustainability reports in 2019 using various third-party standards. A 2018 report found that 78 percent of S&P 500 companies issue sustainability reports, with 95 percent of these reports including quantitative environmental performance metrics and 36 percent of the reports being subject to external assurance. Similarly, according to a 2020 Status Report by the Task Force on Climate-related Financial Disclosures (TCFD), “nearly 60 percent of the world’s 100 largest public companies support the TCFD, report in line with the TCFD recommendations, or both,” and “42 percent of companies with a market capitalisation greater than $10 billion disclosed at least some information in line with each individual TCFD recommendation in 2019.” The TCFD Status Report also shows an increase in reporting of climate-related data “by six percentage points, on average, between 2017 and 2019.” While the SEC can, and should, reference these third-party estimates, they should also conduct their own analysis of company filings and sustainability reports.
Additionally, the SEC should consider what disclosures companies are already making to foreign regulators, such as what may be required under European disclosure mandates. The SEC should also consider what may be disclosed to other federal agencies, such as the Environmental Protection Agency, or state regulators.
If the Commission finds that those firms who do disclose climate information are doing so primarily in ESG or sustainability reports, and not in 10Ks or 10Qs, the Commission will then have to estimate the costs of providing this information in SEC filed reports, provided that is what the proposed rule calls for. And if they find that many firms do not disclose any climate information, it does not necessarily imply that the costs involved in requiring them to provide such information are high. We know that many other firms and financial institutions are asking their suppliers and clients for climate risk information to better understand their own unique counterparty and supplier risks and to calculate their carbon footprint, including scope 3 emissions.[7] For instance, several large banks have made net-zero commitments that can only be measured and assessed if they ask for, and receive, climate information from their customers, i.e., borrowers. Determining how many firms are being asked for, and supplying, this information is a difficult task, but the SEC should attempt to measure it while explaining the inherent uncertainties in such an estimate.
Establishing a baseline is also important for the users of disclosures. For example, some long-term investors (such as CalPERS) expend significant resources to obtain what is often very costly and limited information. Further, their efforts are often impeded by receiving different information—or no information at all—from similarly situated companies. The SEC should seek to identify and quantify the impact the current disclosure framework has on investors, credit ratings agencies, index providers, and customers in terms of time and cost.
Further, in its baseline assessment, the SEC should include qualitative evaluations of the impacts of information failures and inefficiencies on capital allocation. For example, how can a credit rating agency accurately identify and assess the risks of a Rule 144A debt offering by a large fossil fuel company that doesn’t come due for 20 years if the private offering documents don’t include any discussion of climate-related risks? How does that impact the identification and assessment of the credit risk of the security? How does that impact the pricing of the security?
Without disclosure of all relevant information, the credit risk for any given company may be improperly assessed as lower than it is in reality, and its cost of capital may be inefficiently low—to the detriment of lenders or debt investors. Further, this cost of capital distortion may unfairly impact the competition between companies and securities issuers. Higher-risk securities issuers may not be charged the appropriate premiums, while investors and other market participants may be over-investing their time, energy, and capital in sub-optimal ventures.
Identifying Alternatives
The CBA should include an assessment of “reasonable alternatives” to new disclosure requirements on issuers of securities. The fifteen questions, and the multiple sub-questions, in the March RFPI identify several components of a climate disclosure rule that the Commission is considering. Once a proposed rule is released, the Commission’s CBA should address why certain alternatives mentioned in the RFPI were left out of the rule.
Some of the significant decisions the SEC must make are: 1) Who should make disclosures? (2) To whom should disclosures be made? (3) What form should the disclosures take (i.e., should they be posted on issuers’ websites, furnished to the SEC, or “filed” with the SEC)? (4) Should disclosures be tiered or scaled based on the size and/or type of registrant? (5) What processes should be used to ensure reliability of disclosures? (6) What should be the liability and to whom? (7) To what extent should the Commission rely on third-party standard setters in establishing and maintaining climate disclosure rules?
How a proposed rule addresses these questions will dictate the substance of potential alternatives in the CBA. However, as the Chamber court found: “the Commission is not required to consider ‘every alternative . . . conceivable by the mind of man . . . regardless of how uncommon or unknown that alternative’ may be.”[8] Still, the Commission should pay particularly close attention to alternatives proposed by other commissioners, especially those that are likely to vote against a proposed rule.
Republican Commissioners Roisman and Peirce have repeatedly expressed skepticism about the need, and the SEC’s legal authority, to mandate climate risk disclosures. Both have asserted that if climate risks are “material” to a reporting company, then they should already be disclosed. Commissioner Roisman even noted that securities laws provide “a private right of action for misstatements and omissions in SEC filings” and that this provides a “good incentive” to “disclose material information, ESG or otherwise.”
These views were also one of the intended takeaways of the SEC’s 2010 Guidance regarding climate-related disclosures under SEC Regulation S-K. Unfortunately, that guidance appears to have not worked very well. Earlier this year, then Acting Chair Lee announced a staff review of the 2010 Guidance and explained that:
“As part of its enhanced focus in this area, the staff will review the extent to which public companies address the topics identified in the 2010 guidance, assess compliance with disclosure obligations under the federal securities laws, engage with public companies on these issues, and absorb critical lessons on how the market is currently managing climate-related risks.”
In a public statement from March, Commissioners Peirce and Roisman welcomed “any recommendations the staff may have with respect to enhancing our interpretive guidance to meet investors’ needs for information material to their financial decision-making consistent with our Congressionally-mandated mission and authority.” Therefore, a proposed climate disclosure rule, if premised on a materiality standard, should seek to explain why current law, coupled with an update to the 2010 guidance, is insufficient to compel the necessary climate-related disclosures.[9]
Similarly, as Commissioners Roisman and Peirce have also acknowledged, some market participants are already demanding the disclosure of ESG information, regardless of materiality, and therefore the SEC need not intervene to compel disclosure. For example, Commissioner Roisman noted that “[i]t is important to realize and acknowledge that companies provide information and act without the government telling them to do so for many different reasons, including because their customers, employees, and others motivate them to do so.”
It is true that a growing number of companies are choosing to disclose climate and other ESG information. Therefore, the SEC’s CBA should explain how the growth in voluntary disclosures has led to “inconsistent, difficult to find, and often not comparable” climate information, and why that is inadequate for market participants to use in making informed business decisions, which form the bedrock of “fair, orderly, and efficient” markets.
Evaluating the Benefits and Costs
Determining which benefits and costs to include, and seeking to measure or otherwise quantify them, is where the rubber meets the road in any CBA. The 2012 Guidance lays out a series of four steps:
“(1) identify and describe the most likely economic benefits and costs of the proposed rule and alternatives; (2) quantify those expected benefits and costs to the extent possible; (3) for those elements of benefits and costs that are quantified, identify the source or method of quantification and discuss any uncertainties underlying the estimates; and (4) for those elements that are not quantified, explain why they cannot be quantified.”
Costs
The costs of a rule should factor in the costs for both those who comply with the rule and those who are the intended beneficiaries. For example, one company required to disclose something in a reliable, consistent, and comparable way may be incurring greater costs, but that may also lead to significantly reduced aggregate costs for dozens, hundreds, or thousands of individuals or businesses who would read and seek to use those disclosures.
Again, establishing baselines is important. If the SEC argues that many registrants are already disclosing some form of climate risk information (in foreign jurisdictions, to other regulators, or to selected investors pursuant to voluntary practices), then the compliance costs for mandatory disclosure may be less than otherwise anticipated.
In general, the SEC should consider the compliance costs, direct costs, and indirect costs of any proposed rule. In the case of a proposed climate disclosure rule, the compliance costs could include additional staff that are hired to produce the disclosures, upgrades to information systems to capture GHG emissions, and the hiring of consultants, lawyers, and accountants to ensure climate disclosures are accurate and verified.
Estimates vary significantly regarding the amount of overlap between what’s being disclosed now and what may be desired by investors and market participants. In its May 2021 cost estimate of the Climate Risk Disclosure Act of 2021, the Congressional Budget Office (CBO) “estimate[d] that a small portion, about 15 percent, of public companies are currently reporting information related to climate change to investors” and “the aggregate costs for publicly traded companies to comply with the new rules may be substantial.”
The CBO’s estimate for the proportion of firms currently disclosing climate information is significantly below other third-party estimates, which is another reason why it is critical for the SEC to conduct its own independent estimate. In addition, for firms that are already disclosing climate information, the SEC should engage with them to quantify the costs of voluntary disclosure, recognizing that this cost will vary by sector, firm size, jurisdiction, and other factors.
As Commissioner Peirce recently pointed out, compliance costs are ultimately borne by shareholders, in the form of less capital that is available to them as dividends or share repurchases. If shareholders receive material information in return, these costs may be worth it. But if the Commission justifies mandatory climate disclosure on public interest grounds or any other non-materiality standard, a court may find the benefits do not outweigh the costs.
As defined in the 2012 Guidance, direct costs represent “intended changes to the behavior of regulated firms or persons” in response to the new rule. The purpose of mandatory climate disclosure is to provide investors and other market participants with the information they need to make informed business decisions, including efficiently allocating their resources. We assume that the SEC is simply looking to require disclosures and will not adopt a substantive prohibition on taking any action (except for potentially limiting or conditioning the use of certain labeling or marketing claims related to climate-related financial products). As a result, the direct costs to issuers are generally minimal, as there are no “intended changes” at regulated firms the rule is striving for beyond the production of climate disclosure.
However, we also assume that once provided with the information, market participants may seek to apply pressure to companies to change their corporate behavior. This may lead to companies becoming “greener” through decisions such as purchasing more sustainable energy. However, this is not an intended effect of the rule so it would likely fall under indirect costs. Furthermore, it may not be a cost at all given the rapidly declining price of renewable energy.
Indirect costs are even harder to quantify, but for a climate disclosure rule, they may be significant. The 2012 Guidance notes that indirect costs can include:
- the distributional and competitive effects of the rule;
- negative collateral consequences, such as the potential misuse of newly created rights; and
- a misallocation of resources resulting from regulatory arbitrage (race to the bottom).
Here again, the Commission should consider the critiques of mandatory ESG disclosure leveled by Commissioners Roisman and Peirce. In a recent speech, Commissioner Peirce laid out ten ESG critical theses that were informed by her review of the comments to the March RFPI, some of which reflect concerns around the indirect costs a mandatory disclosure regime would impose. For example, she notes that many non-investor advocacy groups “hope to use the securities laws to force issuers to make disclosures about ESG issues important to them and ultimately to compel companies to make behavioral changes” and that these groups “know that requiring public disclosures about particular employment or environmental activities might cause issuers to avoid those activities altogether, regardless of the costs of those changes to the investor.”
Another one of Commissioner Peirce’s critiques centers around the ESG consultants, standard setters, raters, “auditors, lawyers, sustainability professionals, and other rent seekers” who stand to gain from adoption of a mandatory climate risk disclosure regime. Their gain is issuers’, and—by extension—investors’, expense.
Peirce’s final two theses (9 and 10) reflect indirect costs. In thesis 9, Peirce notes: “A very prescriptive climate disclosure framework for issuers together with standards for asset managers that key off that framework would change behavior and move capital to companies and investment products that perform well according to the selected metrics and away from those that do not.” This, according to Peirce, brings the SEC into the unprecedented position of directing capital flows to favored sectors: “We typically do not tell investors whether we think their decisions are financially, let alone morally, good.”
In thesis 10, Peirce suggests that mandatory ESG disclosures could actually undermine financial stability by exacerbating “the homogenization of capital flows already occurring as a result of voluntary allocation of capital to ESG investments.” This could lead to a concentration of investment in specific sectors that could prove destabilizing should the “green” bubble burst.
We are not aware of the basis for this consideration, as a disclosure obligation is not an obligation for investors to fund specific companies. That said, the SEC should consider the extent to which climate-related disclosures may be different from other types of disclosures in that they would somehow compel companies or other market participants to take steps to increase market inefficiencies.
The indirect costs raised by Commissioner Peirce are impossible to precisely quantify, but that does not mean they can be ignored. The 2012 Guidance notes that when “costs or benefits cannot reasonably be quantified” the proposed rule should explain why this is so “and include a qualitative analysis of the likely economic consequences of the proposed rule and reasonable regulatory alternatives.” Thus, the SEC’s task in addressing Peirce’s concerns is straightforward. They can acknowledge the possibility that by requiring the disclosure of climate-related risks, capital flows may change, but presumably that is a consequence of any disclosure rule, climate or otherwise. We would expect that business practices would change as a result of disclosures. Customers may seek to change suppliers based upon their own risk assessments or even just personal preferences. That will impact companies’ bottom lines. So too, will bank lenders’, credit rating agencies’, and index providers’ assessments of credit risk. These market participants—acting independently and in concert—play essential roles in the efficient allocation of capital. To the extent that they are inhibited in their abilities to do that now because of information gaps related to climate-related risks and opportunities, the provision of this information will lead them to modify their assessments, with corresponding impacts on companies.
Another indirect cost is the incentives a climate disclosure rule provides firms to go or stay outside of the disclosure framework. Currently, the SEC’s disclosure regime generally only applies to publicly reporting companies. It is reasonable to think that if the SEC expands its disclosure requirements and accountability apparatus for public companies, it will provide greater incentive to go or stay private. This pressure will likely be greatest in industries with perhaps the largest climate-related risks, such as fossil fuels, real estate, and financial services. The Commission hinted at this possibility in the March RFPI when they asked:
“What climate-related information is available with respect to private companies, and how should the Commission’s rules address private companies’ climate disclosures, such as through exempt offerings, or its oversight of certain investment advisers and funds?”
It is extremely difficult to quantify the number of firms that will chose to go or stay private as the result of any “public only” disclosure requirements, and any resulting impact on investor protection; fair, orderly, and efficient markets; or even capital formation. Further, the nature and extent of the impacts on both public and private companies—across sectors and firm sizes—will vary widely based upon the specific components of a rule.
Benefits
The language around benefits in the 2012 Guidance clearly sets forth circumstances that apply to climate risks:
“[W]here the rule is being proposed to remedy a market failure in the form of inadequate information available to investors, and the rule would require new or enhanced disclosure, the likely benefits to be derived from the rule presumably would include better informed investment decisions.”
In a recent public statement on the costs of ESG disclosures, the Acting Director of the Division of Corporate Finance, John Coates, noted that:
“[c]onsideration of such costs is important, as is getting clear about their causes. But just as important is the recognition of the costs associated with not having ESG disclosure requirements.”
Not only is climate change itself a market failure—the costs of GHG emissions are not borne by emitters—but so too is a lack of reliable and consistent climate risk information. When firms fail to disclose, or disclose unreliable climate information, the costs fall on investors and other market participants, who must undertake extensive research to understand the risks climate change poses to their resource allocation decisions. In his recent speech, Chairman Gensler made clear that it is investors who are motivating the SEC’s proposed rulemaking on climate disclosures:
“Today, investors increasingly want to understand the climate risks of the companies whose stock they own or might buy…Investors are looking for consistent, comparable, and decision-useful disclosures so they can put their money in companies that fit their needs.”
The SEC should not stray from its mission when describing the benefits of mandatory climate risk disclosure: protecting investors; maintaining fair, orderly, and efficient markets; and facilitating capital formation. While some commenters recognize the potential for climate disclosures to motivate firms to engage in more sustainable business practices, we do not think the SEC should focus on these more amorphous benefits. Such recognition would be grist for the mill to critics who believe the SEC is simply attempting to use its authority over securities markets to reduce greenhouse gas emissions. As these critics rightly point out, reducing emissions falls outside the SEC’s remit, and claiming such a benefit in a climate disclosure rule would likely invite additional judicial scrutiny.
Conclusion
The substance of a CBA will depend on what is included in a proposed climate disclosure rule. In his recent speech, Chairman Gensler hinted at his thinking when he noted that he has asked SEC staff to:
- “consider whether these disclosures should be filed in the Form 10-K”;
- “consider a variety of qualitative and quantitative information about climate risk that investors either currently rely on, or believe would help them make investment decisions going forward”;
- “make recommendations about how companies might disclose their Scope 1 and Scope 2 emissions, along with whether to disclose Scope 3 emissions — and if so, how and under what circumstances”[10];
- “consider whether there should be certain metrics for specific industries, such as banking, insurance, or transportation”; and
- “consider which data or metrics those companies might use to inform investors about how they are meeting those [Paris Agreement or Net Zero] requirements.”
As SEC staff weigh each of these issues, they should consider the corresponding costs and benefits, not only for each recommendation, but also for alternatives not chosen. Doing so will strengthen the SEC’s case if a legal challenge comes.
In fact, the battle lines have already been drawn. A comment letter submitted by twelve Republican Senators noted that if the SEC designates a third-party climate disclosure standard setter, it would be an “unlawful delegation of regulatory authority” and violate Chairman Gensler’s commitment, made during his confirmation hearing, to subject new regulations to a “robust cost-benefit analysis by the SEC.”[11] Similarly, Commissioner Roisman has warned about the high costs associated with disclosing information “that is based on uncertain underlying assumptions, or is difficult to calculate” and he hopes the Commission “can predict these costs clearly enough to mitigate them in our rulemaking process.”
Although Commissioner Lee has persuasively argued that limiting SEC rulemaking to requiring disclosures that are material “is legally incorrect, historically unsupported, and inconsistent with the needs of modern investors, especially when it comes to climate and ESG,” basing a climate disclosure rule on anything other than materiality may be considered by a court to be a “departure from previous approaches to regulation.” While Sections 7 and 10 of the Securities Act authorize the SEC to require disclosures that are ““necessary or appropriate in the public interest or for the protection of investors,” a climate disclosure rule based on promoting the “public interest” should be accompanied by supporting analysis in the administrative record and CBA.[12] As the history of judicial review of agency rulemaking reveals, courts can consider agency rules to be arbitrary and capricious under the APA when the rule’s purported benefits are not precisely quantified or are open to interpretation, as could be the case if a rule is promulgated primarily on public interest grounds.
A well-crafted and well-reasoned climate risk disclosure rule should withstand judicial scrutiny. But if the agency includes other ESG factors in its rulemaking, it could spell trouble. As professor Amanda Rose noted: “Requesting that the SEC adopt a framework for companies to use to disclose information on a broad set of topics, without establishing that any one of those topics is in fact financially material, is an unusual foray into SEC rulemaking.”
It is telling that Commissioner Roisman and Peirce’s public remarks tend to focus on ESG broadly, and not just climate. This is a clever rhetorical device, as they know Social and Governance factors are inherently more political—there are few outright climate deniers in either major political party these days. But this summer’s extreme weather events are yet another reminder of the clear linkage between climate change and financial loss. The climate crisis is here, and its impact on companies, as well as their investors, lenders, suppliers, customers, and other stakeholders is growing. Investors and other market participants are clearly struggling to obtain the reliable, consistent, and comparable climate-related information they need to make informed business decisions. The SEC cannot delay in implementing a mandatory climate risk disclosure regime. Any robust cost-benefit analysis will reveal that the benefits to investors and society clearly justify the costs of compelling climate related disclosures.
Mario Olczykowski is a research assistant at the Global Financial Markets Center
Lee Reiners is the executive director of the Global Financial Markets Center
[1] Chamber of Com. of U.S. v. Sec. & Exch. Comm’n, 412 F.3d 133, 142 (D.C. Cir. 2005).
[2] Bus. Roundtable v. S.E.C., 647 F.3d 1144 (D.C. Cir. 2011).
[3] Id.
[4] Id. at 1151.
[5] Prior to 2011, SEC rulemaking releases often included separate sections captioned “Cost Benefit Analysis” (“CBA”) and “Efficiency, Competition, and Capital Formation” (“ECCF”). Post-2011, the SEC combined CBA and ECCF sections into a single “Economic Analysis” section that discusses the economic consequences in a more comprehensive manner or by incorporating the economic analysis throughout the release rather than in a dedicated section.
[6] H. Rep. 73–85 (1933), at 2–3.
[7] Scope 3 emissions are the result of activities from assets not owned or controlled by the reporting organization, but that the organization indirectly impacts in its value chain.
[8] Chamber I, 412 F.3d at 144 (quoting Motor Vehicle Mfrs. Ass’n v. State Farm Mutual Auto. Ins. Co., 463 U.S. 29, 51(1983)).
[9] Commissioner Lee has noted that the SEC also has the legal authority to compel disclosure of certain items even if they are not deemed material to a reasonable investor.
[10] Scope 1 covers direct emissions from owned or controlled sources. Scope 2 covers indirect emissions from the generation of purchased electricity, steam, heating and cooling consumed by the reporting company.
[11] It seems that the SEC discarded the possibility of designating a third-party standard setter to develop a climate disclosure standard. In the Q&A session last week, Chairman Gensler, asked about the SEC’s cooperation with international third-party standard setters in developing the climate disclosure rule, stated: “we will be informed and inspired by the international communities’ work, but . . . under our authorities and our jurisdiction we will move forward to put out a rule . . . grounded of course in our authority and our economic analysis.”
[12] 15 U.S.C. §§ 77g(a)(1), 77j(c).
