In March 2022, prior to the publication of the SEC’s proposed rule on climate-related disclosures––The Enhancement and Standardization of Climate-Related Disclosures for Investors (Proposed Rule), former SEC Commissioner Allison Lee gave a speech where she argued that the Commission can do whatever it wants in regard to climate change related disclosures: “We have broad authority to prescribe disclosure requirements as necessary or appropriate in the public interest or for the protection of investors.” Such a conclusory statement brings to the fore a critical issue—what are the legal limitations of the SEC’s rulemaking authority in general and, more specifically, in the area of climate-related disclosures?
Not surprisingly, comment letters in response to the Proposed Rule identified such limitations, including those based on the First Amendment. Most importantly, the U.S. Supreme Court’s decision in West Virginia v. Environmental Protection Agency established that the “major questions” doctrine (a legal doctrine which limits an agency’s power to act on issues of “economic and political significance” without clear authorization from Congress) may be a significant impediment to the finalization of the Proposed Rule.
My new article, “The Ascertainable Standards that Define the Boundaries of the SEC’s Rulemaking Authority,” presents a new argument against finalization. This argument finds its authority in the “ascertainable standards” that are found in the statutes—the Securities Act of 1933 and the Securities Exchange Act of 1934 (the Acts)—that underlie the Proposed Rule. Ascertainable standards are both (1) policy objectives that the Board must use in its decision-making, including rulemaking, and (2) what a reviewing court will use when determining if the Board has acted in an “arbitrary and capricious” manner or has crossed the boundaries of its statutory authority under Section 706 of the Administrative Procedures Act (APA).
There are three ascertainable standards in the Acts: (1) investor protection, (2) promoting “efficiency, competition, and capital formation,” and (3) materiality. This triad of standards can be broken down into two policy objectives and one policy constraint. Investor protection—which a historic understanding of the Acts limits to informing investors of firm-specific investment risk—is the primary objective. Promoting “efficiency, competition, and capital formation” is a secondary objective. Materiality can be thought of as a “soft” constraint, a condition that is required unless a non-material disclosure is necessary to facilitate the two policy objectives. Moreover, looking at the Acts through this lens makes clear that materiality, contrary to mainstream thinking, does not stand alone as a means to limit the SEC’s rulemaking authority.
The identification of ascertainable standards, found in all statutes with a regulatory component (“regulatory statute”), is necessary because of the nondelegation doctrine and its “intelligible principle” test. The nondelegation doctrine was created by the U.S. Supreme Court to help enforce our constitutional separation of powers. As such, it requires Congress to refrain from transferring its legislative functions to another branch of government (e.g., making broad grants of discretionary authority to an administrative agency) unless Congress “shall lay down by legislative act an intelligible principle to which the person or body authorized to [exercise the delegated authority] is directed to conform . . . .”
As stated by Justice Rehnquist in his concurring opinion in Industrial Union Dept., AFL-CIO v. American Petroleum Institute, Congress’s identification of an intelligible principle is critical in directing the decision-making of an agency, including its rulemaking, and for the courts when they review an agency rule under the APA:
As formulated and enforced by this Court, the nondelegation doctrine serves three important functions. First, and most abstractly, it ensures to the extent consistent with orderly governmental administration that important choices of social policy are made by Congress, the branch of our Government most responsive to the popular will. Second, the doctrine guarantees that, to the extent Congress finds it necessary to delegate authority, it provides the recipient of that authority with an “intelligible principle” to guide the exercise of the delegated discretion. Third, and derivative of the second, the doctrine ensures that courts charged with reviewing the exercise of delegated legislative discretion will be able to test that exercise against ascertainable standards. (citations omitted).
In the Public Interest
The triad of ascertainable standards are also used to fill in the blanks of what Congress meant when it repeatedly inserted the vague term of “in the public interest” into the Acts. This term only becomes understandable when it is animated with these ascertainable standards. In this context, determining whether an action is “in the public interest” can be thought of as a maximization problem with two constraints. What is being maximized when the SEC requires climate-related disclosures is “investor protection.” This is the primary mission of the Acts.
The first constraint of this maximization problem is actually the secondary objective, the promotion of efficiency, competition, and capital formation. A SEC action can never have an expected negative effect on the promotion of efficiency, competition, and capital formation, so this is a constraint on what the SEC can do to promote investor protection. The second constraint is materiality. Congress has provided significant evidence that it intended the SEC to focus on material disclosures as the primary means of protecting investors. Nonetheless, non-material disclosures may be required if it can be shown that they advance investor protection and have at least a neutral impact on the promotion of efficiency, competition, and capital formation.
The Overall Impact
What should also be apparent is that, no matter which administration is in power, the more one can identify ascertainable standards with substantive meaning, the more restraints Congress is placing on an agency’s discretionary authority to act. In that regard, investor protection; making sure disclosures will actually enhance efficiency, competition, and capital formation and not lead to their reduction; and the constraint of materiality require the SEC to be very cautious in its approach to promulgating rules, including climate-related disclosure requirements.
Moreover, it would not be surprising to find that if an ascertainable standard review of all SEC rules and interpretations were to occur, many of them would be found to violate the boundaries of authority created by the identified standards. For example, the SEC takes the position that it has extremely broad authority to compel public companies to include shareholder proposals on social issues in their proxy statements. By taking this position, the SEC is showing a blatant disregard for the three ascertainable standards that permeate the Acts and the boundaries of authority that they create.
What the SEC Can Do in Requiring Climate-Related Disclosures
When these ascertainable standards are applied to the Proposed Rule, a court is likely to find that the SEC has exceeded its authority. For example, none of the required disclosures involving Scope emissions meet the requirements for investor protection or are material to reasonable investors. Thus, the Proposed Rule is at risk of being set aside in whole or in part.
If so, what can the SEC do in the way of climate-related disclosures? The required approach is already found in the 2010 Guidance where the focus is on disclosing material risk factors “that make an investment in the registrant speculative or risky” or “are reasonably likely to have a material effect on [a public company’s or registrant’s] financial condition or operating performance.” However, certain updates are definitely required. Since 2010, investors have become more aware of the risks climate change poses to our economy, and an update of that guidance with more examples of firm-specific investment risk that a reporting company needs to disclose would be useful. For example, investors are becoming better informed of low probability, high impact climate change events that may materially harm a reporting company. Moreover, even if the risk of these events has already been disclosed, further disclosure may be required if the probability and/or impact of such events have increased over the years.
The complete article is available here.
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