The following post comes to us from George Georgiev at Emory Law.  It follows quite nicely on Ann’s post yesterday on Climate Change and Wahed Invest.  I know a bunch of us will be commenting over time on the SEC’s climate change release, and we are grateful that George has offered his ideas here.  Please note that more of the post is below the fold and can be accessed by clicking on the “continue reading” jump link.

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The SEC’s Climate Disclosure Proposal: Critiquing the Critics
George S. Georgiev

The SEC released its long-awaited Climate Disclosure Proposal a few days ago, on March 21, 2022. The Proposal is expansive, the stakes are high, and, predictably, the critical arguments that started appearing soon after the SEC kicked off this project a year ago are being raised ever more forcefully in preparation for a potential court challenge. A close review of the Proposal, however, suggests that it is firmly grounded within the traditional SEC disclosure framework that has been in place for close to nine decades. The Proposal is certainly ambitious (and overdue), but it is by no means extraordinary. This, in turn, suggests that challenges to the Proposal’s legitimacy ought to fail, even if certain aspects of the Proposal could stand to be improved as part of the ongoing rulemaking process.

This view is not universally held. In voting against the Proposal, SEC Commissioner Hester Peirce admonished that it “turns the disclosure regime on its head” and erects “a hulking green structure” that will “trumpet” a “revised mission” for the SEC: “‘protection of stakeholders, facilitating the growth of the climate-industrial complex, and fostering unfair, disorderly, and inefficient markets.’” This certainly sounds problematic—and, indeed, quite dramatic. But once we set aside the entertaining rhetorical flourishes, we see that many of the arguments against the Proposal misstate the applicable legal constraints and mischaracterize important aspects of the Proposal. Moreover, even though Commissioner Peirce goes out of her way to praise “the existing regulatory framework that for many decades has undergirded consistent, comparable, and reliable company disclosures,” her lengthy dissenting statement reveals that she actually opposes many important and established elements of the very framework she says she wants to conserve.

I will make the case that the SEC’s Climate Disclosure Proposal is in keeping with longstanding regulatory practice by examining several features of the traditional disclosure regime and the new Proposal. I will focus my analysis on arguments I’ve developed in prior research, certain other less-known arguments, and the particular aspects of the new Proposal. This piece is not intended to be comprehensive, and I want to note that the broader issue of ESG disclosure has generated extensive debate and much insightful analysis. As always, I welcome comments and amendments via email.

Shareholders, Stakeholders, and Expert Groups

The SEC’s Climate Disclosure Proposal immediately prompts the well-worn question: Is this disclosure intended for shareholders or for stakeholders? But posing this as a binary choice automatically shifts the terms of the debate in favor of opponents of climate-related disclosure, regardless of the actual content of the Proposal. Since climate change has society-wide implications, information about it will inevitably resonate beyond the boundaries of the disclosing firm and the capital markets, even when the focus is on financially-material disclosure relying on investor- and issuer-generated disclosure frameworks (as is the case here). The social resonance of climate-related disclosure can drown out its clear-cut financial relevance, render any proposed disclosure rule suspect, and lead to a situation that, when we stop and think about it, is quite illogical: A subject matter’s relevance to one audience (stakeholders) is used as an argument to cancel out the well-established relevance of that same subject matter to another audience (investors). This is a general vulnerability that applies not just to climate-related disclosure, but to other ESG disclosure as well. It is important to understand it and de-bias policymaking accordingly.

Commissioner Peirce’s dissenting statement deftly zeroes in on this vulnerability by asserting that the Proposal “tells corporate managers how regulators, doing the bidding of an array of non-investor stakeholders, expect them to run their companies” and “forces investors to view companies through the eyes of a vocal set of stakeholders, for whom a company’s climate reputation is of equal or greater importance than a company’s financial performance.” Reading this, one would think that the Proposal was written by the Sierra Club and the National Resources Defense Council—or by a D.C. bureaucrat, who, in Peirce’s telling, is both clueless and corruptible. Yet, nothing could be further from the truth. 

The SEC’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. Take the TCFD, for example: Its members include representatives of mainstream investors (including BlackRock and UBS Asset Management), banks (JP Morgan, Citibanamex), insurance companies (Aviva, Swiss Re, Axa), giant industrial firms (BHP, Eni, Tata Steel, Unilever), rating agencies (Moody’s, S&P), accounting firms (Deloitte, E&Y), and others. Its secretariat is headed by a leader in the financial industry and capital markets, Mary Schapiro, who holds the unique distinction of having served as Chair of the SEC, Chair of the CFTC, and CEO of FINRA. And, for better or worse, no environmental NGOs or stakeholder organizations are represented on the TCFD. As its name suggests, the TCFD’s focus is on financial disclosures of the kind that investors require and use. The TCFD has generated an impressive roster of supporters and official adopters in just over six years, and, importantly, each of the “big three” (BlackRock, State Street, and Vanguard) has endorsed the TCFD framework.

Commissioner Peirce rightly points out that the SEC does not have the depth of expertise on climate-related matters that other, specialized regulators have. Such expertise, however, is not necessary here since the SEC is not setting GHG emission limits, calculating carbon trading prices, drawing up climate transition plans, or setting climate resilience standards for businesses. The SEC’s Proposal is limited to disclosure—and only disclosure—on a technical topic, and the SEC has decades-long experience handling disclosures on technical topics. For example, the SEC is not an energy regulator, but 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 SEC has had to develop some expertise in cybersecurity disclosure, tech disclosure, and in other specialized areas. The Climate Disclosure Proposal does not veer away from this time-tested approach; the only difference is that it concerns a hot-button topic.

Statutory Authority and Regulatory Practice: Recalling Schedule A of the Securities Act

A central challenge to the Proposal is that it goes beyond the authority given to the SEC by Congress because the rules are too prescriptive, not rooted in “materiality” (more on which later), and because Congress has not directed the SEC to pursue rulemaking on this particular topic. A fair amount of debate has focused on what it means for the SEC to act as “necessary or appropriate in the public interest or for the protection of investors”—language that has been part of the securities laws since they were passed in the 1930s but that has not been tested in court.