An Overview of Legal Arguments Against the SEC's New Climate Disclosure Requirements
No one seems to be happy with the climate disclosure rules adopted by the U.S. Securities and Exchange Commission (SEC) on March 6th, 2024, which would require SEC registrants to provide information about their emissions and climate-related risks in registration statements and annual reports. The SEC originally proposed the rules on March 22nd, 2021, and finalized them in the intervening two years after receiving over 24,000 (4,500 unique) public comment letters from interested parties spanning academics, publicly traded companies, entities in the accounting, legal, investment, and climate advisory fields, as well as federal and state government officials. However, on April 4th, 2024, the SEC issued a voluntary stay on the rules as legal challenges from U.S. states, energy companies, pro-business groups, and climate advocates mounted in the days following their official adoption. Many parties argued that the SEC overstepped its authority in adopting the rules, that they violated the First Amendment’s restrictions on compelled speech, and that they were arbitrary and capricious. Some parties, though, argued that the rules did not require sufficient climate-related information from companies to protect investors. The bottom line: some say the rules go too far, others say not enough. The SEC stated its commitment to defend the rules’ validity in court, and though their future hangs in the balance for the time being, other climate disclosure requirements that have been passed both in the U.S. and around the globe make it clear that companies will likely have to adapt to similar measures sooner or later.
The SEC’s climate disclosure rules, justified by the agency in terms of the spirit of existing federal securities legislation, would require SEC registrants to include information about material climate risks in registration statements and annual reports. The SEC’s premise in formulating the rules was that market participants have acknowledged that climate-related risks can have significant effects on companies’ current and future financial performance and that investors need “more consistent, comparable, and reliable information about the financial effects of climate-related risks on a registrant’s business, as well as information about how the registrant manages those risks.” Current SEC Chairman Gary Gensler further rationalized the climate disclosure rules as strengthening the “basic bargain” embodied by federal securities legislation under which investors take risks in allocating their capital to companies, which in turn must provide “complete and truthful disclosure.” In other words, the SEC’s reasoning behind the new rules was that (1) climate-related risks materially affect registrants’ financials, (2) investors must have more information about these risks and their financial effects, and (3) mandating registrants provide such information aligns with the ethos of existing federal securities laws. With the preceding theoretical underpinning, the climate disclosure rules first mandate that registrants report “[c]limate-related risks that have had or are reasonably likely to have a material impact on the registrant’s business strategy, results of operations, or financial condition.” These risks subdivide into physical risks like hurricanes and floods, on one hand, and transition risks that derive from a potential shift towards a more sustainable economy, on the other. Among other provisions, the rules specify that registrants should share “[t]he actual and potential material impacts of any identified climate-related risks on the registrant’s strategy, business model, and outlook.” Non-exempt registrants that meet the Large Accelerated Filer (LAF) and Accelerated Filer (AF) thresholds have to present information about material Scope 1 and Scope 2 greenhouse gas emissions, which are directly and indirectly produced by the registrant, respectively. The rules were set to be phased in and applied to registration statements and annual reports filed with the SEC according to the classification of registrants over the next several fiscal years.
The SEC’s climate disclosure rules were met with immediate legal challenges from U.S. states, energy companies, pro-business organizations, and environmental groups. On the procedural side, nine petitions for judicial review of the rules were filed by varying interests within the first ten days of the rules’ adoption. In response, the SEC asked the Judicial Panel on Multidistrict Litigation to consolidate the disparate petitions for review into one, which will then be litigated in a randomly selected circuit. The Panel granted the SEC’s request two days later and assigned the consolidated suits to the Eighth Circuit. The Fifth Circuit had previously granted an administrative stay of the rules on March 15th, 2024, with respect to one of the original nine cases but dissolved the stay following the Panel’s consolidation order. In any case, the SEC subsequently issued a voluntary stay on the rules to avoid creating regulatory uncertainty for companies to which they would have applied while the judicial review is pending. The SEC made it clear in its stay order that it was committed to defending the rules’ validity in court.
U.S. states, pro-business organizations, and energy companies leveraged varying combinations of a few legal arguments in their petitions against the rules. First, opponents argued that the rules extend beyond the SEC’s rulemaking authority under Section 13(a) of the Securities Exchange Act of 1934, which provides that the SEC may only require public reporting that is “necessary or appropriate for the proper protection of investors and to ensure fair dealing in the security.” Opponents contended that the climate disclosures do not address securities fraud under the scope of Section 10(b) of the 1934 Act, so the SEC is not authorized to require them. Second, opponents argued under the major questions doctrine that explicit congressional direction is necessary for the SEC to impose climate disclosure requirements because they are outside the agency’s current congressional mandate. Third, opponents argued that the rules violate corporations’ First Amendment rights that protect against compelled speech. Under the compelled speech doctrine for corporations, governments can require “purely factual and uncontroversial information” from companies if the disclosures are not “unjustified or unduly burdensome” and serve a government interest. Finally, opponents argued under the Administrative Procedure Act that the rules are arbitrary and capricious given that the SEC maintained for many years that climate disclosures were outside the scope of its authority.
Environmental groups and climate advocates, on the other hand, opposed the rules on the grounds that they did not require enough information from SEC registrants to protect investors. Two major opponents were the Sierra Club and foundation, which took issue with the SEC’s elimination of certain provisions from its originally proposed rules in March 2022. For example, the SEC scrapped requirements for registrants to disclose Scope 3 greenhouse gas emissions, which are the result of activities from assets not owned by the registrant but those that arise from its value chain. More broadly, the Sierra Club claimed the rules allow “companies to selectively report their emissions,” as the SEC explicitly linked climate-related disclosures to their materiality in affecting registrants’ financials — as opposed to mandating the disclosures outright.
The SEC’s new climate disclosure requirements have proven polarizing, drawing criticism and legal challenges arguing both that they are too extreme and not encompassing enough. While the stay on the rules remains in place as litigation pends in the Eighth Circuit, companies to which the rules would have applied have momentary respite from their mandates. Still, given that similar disclosure requirements have been enacted on the state level and in the European Union, it appears that whether or not the SEC’s current rules withstand their present legal challenges, a new era of climate-based disclosures is dawning on the horizon.
Nealie Deol is a fourth-year studying Applied Math-Economics at Brown University. He can be reached at kieran_deol@brown.edu.
Jack Tajmajer is a fourth-year studying Political Science and Economics at Brown University. He can be reached at jack_tajmajer@brown.edu.