SEC Climate Disclosure Rule: A Duck That Quacks By Rupert Darwall
In his recent memoir, former attorney general William Barr recounts how the Trump administration lost its attempt to include a citizenship question in the 2020 census. After losing in the Supreme Court, Barr briefed President Trump on what had gone wrong. “If people were straightforward from the beginning, it could have gotten done,” Barr explained. “The trouble is the administration was too cute by half, and [Chief Justice John] Roberts threw the penalty flag.” The Supreme Court had thrown out the citizenship question because the Commerce department’s declared rationale for it was pretextual—that is to say, it was not the real reason that the Trump administration wanted a citizenship question in the census.
Much comment on the controversial climate disclosure rule proposed by the Securities and Exchange Commission (SEC) has centered on whether the SEC has the necessary legal authority. By the end of the comment period on June 17, the SEC had received more than 3,400 letters, significantly more than usual. Linked to legal arguments on whether the SEC has an adequate statutory—or, indeed, constitutional—basis for its climate proposal is the question of pretextuality: Is the SEC being genuine in the stated justification for its sweeping climate disclosure rules? Should the SEC harbor doubts about its legal standing to compel climate disclosures—notably, greenhouse gas emissions data—from listed companies, it increases the likelihood that it will advance a public justification for the proposed rules that differs from its real one so that it better fits within its statutory authority.
In their comment letter, law professors Jill Fisch and George Georgiev and 28 other law professors argue that the SEC’s climate disclosure proposal “stands solidly on investor and marketplace protection.” Congress had made a broad delegation of power to the SEC 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.” The professors give short shrift to arguments that the SEC’s discretion is bounded by the concept of materiality. Congress had been aware of materiality but did not impose a materiality constraint on the SEC, and the Supreme Court’s materiality test applies to an ex post liability by a court, not to an ex ante policy choice by a regulator.
The flaw in the law professors’ argument is in creating the appearance that the SEC’s regulatory discretion is virtually unbounded. As Bernard Sharfman, Senior Corporate Governance Fellow at the RealClear Foundation, and the Manhattan Institute’s James Copland point out in their comment letter, whenever the term “in the public interest” appears in the Securities Act of 1933 and the Securities Exchange Act of 1934, the phrase “for the protection of investors” almost invariably follows. This, they say, means that the SEC would be committing an arbitrary and capricious act in violation of the Administrative Procedure Act were the SEC to promulgate mandatory disclosures based on a rationale of being “in the public interest” independent of its requirement to consider “the protection of investors” and “efficiency, competition, and capital formation.”
True, Fisch and Georgiev also assert that the SEC’s proposed rules fit within its core responsibility, “by giving investors insight into the amount and timing of cash flows” exposed to climate risk, but they provide no evidentiary basis for their claim. Attempting to find a mechanistic link between a business’s future cash flow and the SEC’s proposed climate disclosures is not so much a moon shot as aiming at the moon with a peashooter. Climate financial risk belongs in a category of what British economist John Kay and former Bank of England governor Mervyn call, in their book of the same title, “radical uncertainty”—a situation in which a list of all possible future outcomes cannot be enumerated, along with the probabilities attached to them. Disclosure, whether mandatory or voluntary, does not change the nature of radical uncertainty or make it less uncertain.
Unlike the 30 law professors, Harvard Law School professor John Coates notes the SEC’s clear, but statutorily limited, authority to the use of disclosure as a tool “for the protection of investors.” Coates, who served in the SEC as its General Counsel in 2021, observes that in March 2021, the SEC issued a request for comment on climate disclosures, which attracted support from investors of all kinds, including individuals and institutions, passive index funds and actively managed funds.
This is not reflected in the weight of citations in the SEC proposal. Professor Lawrence Cunningham and 21 other professors of law, business, and finance note that investors’ demand for climate-related disclosures are “overwhelmingly” institutional asset managers managing other people’s money, not their own. For managers of index funds that must invest in all or substantially all companies in the index, public statements that climate is a top priority “can be an important competitive marketing tool.” While the SEC repeatedly cites the interests of powerful, multitrillion-dollar funds, it mentions individual investors only once in 508 pages. As Sharfman and Copland point out, mandatory climate disclosures are economically advantageous to institutional investors by helping generate Environmental, Social and Governance (ESG) ratings, which, in turn, facilitates creation of ESG funds that are considerably more profitable than low-margin, plain vanilla index funds.
At the heart of the SEC proposal is the disclosure framework developed by the Taskforce on Climate-related Financial Disclosures (TCFD), which is to form the basis of the SEC’s climate disclosure regime. In their comment letter, Boyden Gray & Associates (BG&A) note that the TCFD, referenced 243 times in the SEC proposal, was created, funded, and directed by Michael Bloomberg, whose company intends to develop proprietary tools to become “the financial industry’s first port of call for ESG information” and generate billions of dollars in revenues for companies to comply with the SEC’s proposed disclosure requirements. “The proposed rule is a glaringly clear example of pay-to-play politics and self-dealing,” comment BG&A. “This type of behavior is decidedly not in the ‘public interest.’”
A major source of disagreement is whether the proposed disclosure rule raises First Amendment concerns. No, says Coates. The proposed rule specifies disclosure of facts, not opinions, in neutral language. Not so fast, suggests Professor Sean Griffiths of the School of Law, Fordham University. Compelled commercial speech under the First Amendment needs to meet a test as to whether the required disclosures are “purely factual and uncontroversial.” Information is passive. So are firearms. The focus of many supporters of mandatory climate disclosure cited by the SEC is not investment performance but to facilitate their climate policy goals, argue Sharfman and Copland. Disclosures are a means to an end: to “open the door to public shaming and to aggressive enforcement actions by the SEC, other agencies, state, and local officials, and in particular to private lawsuits by the plaintiffs’ bar.”
In determining whether regulation of commercial speech is purely factual and uncontroversial, courts search for pretext. Pretext points to purpose. “Pretextual purposes are necessarily controversial,” argues Griffiths. “When a state actor claims a purpose that conflicts with its actual purpose, the result is controversy.” Coates has an answer to this, too. “As to motivations,” he asserts, “the long and extensive record leading to the proposal of the rule can be reviewed in its entirety and nowhere will any evidence be found that the purpose of the rule is other than to protect investors.”
In fact, the process started with a speech by then–acting SEC chair Allison Herren Lee, in which she declaredclimate change and ESG “front and center” for the SEC because “investors want to and can help drive sustainable solutions on these issues.” Does that count as investor protection? In October 2021, the Financial Stability Oversight Council (FSOC) delivered a report to the White House in accordance with a May 2021 Executive Orderon climate-related financial risk, which declared it administration policy to advance “consistent, clear, intelligible, comparable and accurate” disclosure of climate-related financial risk in order to achieve goals that expressly include the Biden administration’s target of a net-zero emissions economy by 2050. The FSOC report notes that SEC staff were working on a proposal on disclosure requirements for public issuers and said that it was “encouraged” by the SEC’s work on “this critical issue.”
Most compelling is the internal evidence of the SEC proposal. Its principal defect is taking a sustainability disclosure framework designed to cut corporate greenhouse gas emissions and shoehorning it into a climate transition risk justification. BG&A cite a November 2, 2021, Bloomberg press release quoting Mary Schapiro, a former SEC chair and current head of the TCFD secretariat, explaining the function and purpose of the TCFD: “Disclosure is at the heart of reaching net zero, and the TCFD has provided a solid foundation to support the private sector’s net zero commitments through transparency and accountability.”
In my comment letter, I describe the SEC proposal as Hamlet without the Prince. The proposed rule on greenhouse gas disclosures makes sense only in terms of the SEC’s undisclosed rationale—specifically, to facilitate investor and climate activist pressure on listed companies to cut their greenhouse gas emissions, and not the SEC’s pretextual one of such disclosures being proxies for climate risk. Indeed, the SEC knows its pretextual justification to be spurious, as it acknowledges that transition risk is jurisdiction-specific. Yet under its proposed rule, greenhouse gas disclosures would not be disaggregated by jurisdiction, thereby creating a systematically misleading indicator of climate transition risk that puts it in direct conflict with Congress’s demand that the SEC act to “promote efficiency, competition, and capital formation.”
BG&A conclude that even if the SEC’s proposed rule is otherwise valid, it would still be unlawful because the SEC provided a contrived basis for the rulemaking. Their letter quotes the June 2019 opinion of the Supreme Court in the Department of Commerce v. New York that threw out the citizenship question from the 2020 census: “Our review is deferential, but we are ‘not required to exhibit a naïveté from which ordinary citizens are free.’ ” For the courts to swallow the SEC’s pretextual rationale would require generous levels of credulity and sustained suspension of disbelief. Ordinary citizens are apt to employ the duck test: if it looks like a duck, swims like a duck, and quacks like a duck, then it probably is a duck. The SEC climate proposal is a duck.
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