This post originally appeared at Law360.
In response to multiple lawsuits in multiple federal courts of appeals, the U.S. Securities and Exchange Commission on April 4 decided to voluntarily suspend implementation of its new rule on climate-related disclosures until the U.S. Court of Appeals for the Eighth Circuit has completed its judicial review of these challenges on a consolidated basis.
Why has this new rule generated so much litigation? The answer is that the SEC is on a determined mission to implement its climate policy agenda despite not having the legal authority to do so.
The legal arguments put forth in the consolidated challenges to justify the rule being set aside include a lack of statutory authority, the major questions doctrine and impermissibly compelled speech under the First Amendment.
This article focuses on a lack of statutory authority from a textualist perspective. This means seeking, as Justice Amy Coney Barrett said in the U.S. Supreme Court’s 2023 decision in Biden v. Nebraska, the “text’s most natural interpretation.” This is accomplished by understanding the text in its “linguistic, structural, functional, social, [and] historical” contexts, according to the U.S. Court of Appeals for the Seventh Circuit’s 1989 ruling in Matter of Sinclair.
The SEC states that it is implementing this rule under the authority provided by the Securities Act of 1933 and the Securities Exchange Act of 1934. Not surprisingly, there was no language in the originally enacted acts that referred to climate-related disclosures. Such disclosures were on no one’s radar at the time. But what may be surprising is that no language to that effect was added to the acts as they have been modified with various amendments over the past 90 years.
Nevertheless, to overcome this lack of relevant statutory language referencing climate-related disclosures, the SEC focuses in its final rule on language in the acts where it states that the SEC can require such disclosures when it is “in the public interest or for the protection of investors.” These are two terms that are prominently featured in the acts.
Yet, the SEC does not provide a legal argument that explains how the new climate-related disclosures meet this requirement; it simply says it does. Providing such an argument would require the SEC to give reasonable definitions of “investor protection” and “public interest” that are consistent with the historical context in which the acts were created. These definitions are not provided in the rule.
Arguably, the SEC’s reluctance to provide such definitions is because it would then be forced to acknowledge that there are reasonable boundaries to its climate-related disclosure authority.
For example, given the dominant influence of the Great Depression in drafting the acts, “investor protection” has historically been defined as informing investors of firm-specific investment risk. If so, the SEC would then be limited to requiring climate-related disclosures for this purpose only. It would not be enough to require such disclosures to simply satisfy the curiosity of certain investors or help large investment advisers who want to market higher-cost environmental, social, and governance mutual funds and exchange-traded funds to investors.
Moreover, “in the public interest” is not an open-ended term and must be construed in the context of the applicable regulatory statute. As stated by the Supreme Court in its 1976 decision in NAACP v. FPC: “This Court’s cases have consistently held that the use of the words ‘public interest’ in a regulatory statute is not a broad license to promote the general public welfare. Rather, the words take meaning from the purposes of the regulatory legislation.”
In the context of the acts, this narrows the use of the term “in the public interest” in SEC rulemaking authority to the world of securities investment in the U.S. and the protection of participating investors. This point is made clear when one looks at how the acts consistently place “for the protection of investors” in close proximity to the term “in the public interest.” The close proximity of these terms cannot be a coincidence.
Instead of making the required legal argument to establish its authority, the SEC hides behind the concept of “materiality” to give the appearance that its rule is legally defensible. Material information is limited to information a reasonable investor would want to know to determine whether to buy or sell a security, and is widely regarded as an appropriate filter for disclosure.
In the acts, materiality is a “foundational principle” used to make sure investors are not overwhelmed with irrelevant information. It also helps to make sure companies are not held legally liable for omissions or misstatements that are immaterial to investment decisions.
There are over 1,000 references to “materiality” or “material” in the text of the rule. But, no matter how many references, materiality does not provide the SEC with the authority to require climate-related disclosures. It does not create disclosure authority; it can only serve as a constraint on whatever disclosure authority the SEC has.
Most importantly, it does nothing to substitute for explicit statutory language giving the SEC authority to create its new rule or help make the argument that the rule’s climate-related disclosures are necessary “for the protection of investors” or “in the public interest.” In essence, by using materiality as a rationale for required climate-related disclosures, the SEC has created a false legal standard where it has no legal authority.
Without being able to base its legal authority on statutory language that references climaterelated disclosures, or on an argument that is supported by legal reasoning and reasonable definitions of “for the protection of investors” and “in the public interest,” a reviewing court will be compelled to set aside the new rule under Section 706 of the Administrative Procedure Act, finding that the SEC has acted in an arbitrary and capricious manner and lacks statutory authority to promulgate a climate disclosure rule. To avoid this likely event, the SEC should immediately begin the process of withdrawing the rule.
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