Climate-related disclosures forecast: The Securities and Exchange Commission will adopt climate disclosure rules in 2023; opposition will be fierce; and, unless the proposed rules are retooled prior to their adoption, a court will likely either remand and order that the rules be reworked or vacate them.
Legal challenges should be expected on many fronts—including a major questions doctrine or Chevron deference analysis, and under the First Amendment—and from diverse opponents, such as affected industries, state attorneys general, think tanks, and trade associations. This analysis focuses on whether the SEC complied with the strictures of the Administrative Procedure Act.
Proposal Would Remake Disclosure Regime
The rules, as proposed in March, represent more than simply new rules that will require additional disclosures about a public company’s environmental impact. They are no less than a highly controversial remaking of the US securities disclosure regime. Disclosures required by securities laws have long been predicated on the information being material to investors making an investment decision.
The proposed climate-related rules depart abruptly from that materiality standard. The proposed rules are frequently prescriptive, requiring public companies to gather certain information and disclose it even when the burdens of compliance are significant, and even if the data provided will not be consequential to investment decisions.
After recently reopening the proposed rules’ public comment period, a Commission vote on final rules looks to take place in 2023, perhaps sometime in the second quarter.
How Might the APA Restrict Climate Rules?
Many doubt the SEC’s authority to impose climate-related disclosure mandates on the public companies it regulates.
However, broadly speaking, when any public company information is material to investors, the SEC may require its disclosure. If climate-related disclosures would be material to investors, then those disclosures are already legally mandated under the SEC’s court-tested rules, subject to an economic analysis of the benefits and burdens under the APA.
Under the proposed rules, some climate disclosures will continue to be based on their materiality (e.g., Scope 3, which addresses indirect supply chain emissions, though the burden for compliance would be extremely high), while others are prescriptive (e.g., Scopes 1 and 2, which address direct emissions from operations), such as requiring companies to disclose climate-related risks that total as little as 1% of a total line item in their financial statements.
The proposed prescriptive rules go beyond discussing a material risk or disclosing matters that have a material impact on the business and its finances. The SEC may enjoy some latitude with courts in defining what is material beyond financial concerns, and that could provide some degree of support to courts inclined to defer to the agency’s prescriptive rules approach.
The APA Is an Old Nemesis
The SEC has suffered important defeats to its rulemaking in the US Court of Appeals for the DC Circuit for violations of the APA.
That act mandates that all federal agencies take certain steps when adopting new rules that break with established agency policy, such as the SEC’s departure from the materiality standard (if the agency adopts the climate disclosure rules as proposed).
The SEC will need to show courts that it performed a rigorous economic analysis assessing the benefits and costs imposed on companies required to comply with those new rules, including demonstrating that it studied how the proposed climate rules would affect efficiency, competition, and capital formation.
To meet APA requirements, the agency can’t have acted in an arbitrary or capricious way, and must have addressed significant comments from the public about the proposed rules. Comments considered significant are those that challenge a fundamental premise underlying the rule change, raise significant issues, or make claims that—if true—would necessitate that the proposed rule be altered.
Overcoming the Arbitrary-or-Capricious Hurdle
For informal agency rulemaking, such as here, federal courts will set aside the commission’s climate rules if the SEC is found to have acted in a manner that the APA defines as “arbitrary, capricious, an abuse of discretion, or otherwise not in accordance with law.”
Key court considerations include:
- the expected compliance burden and less-costly alternatives;
- the effect on efficiency, competition, and capital formation; and
- whether the rules were made through reasoned decision-making supported by substantial evidence.
There’s widespread concern over the cost that rules requiring such detailed disclosure will impose on the roughly 6,000 affected public companies. Many companies would need to build substantial climate reporting infrastructure to comply, in addition to the cost of collecting, analyzing, and reporting data. The proposal would create a much more expansive, complex, and expensive reporting regime with financial risks sharing the stage with climate concerns. The SEC has admitted that its economic analysis is unable to reliably quantify costs and benefits.
The burden of the proposed rules could dissuade companies from going public and could incentivize existing public companies to go private to avoid these mandates, arguably impeding capital formation and limiting the investment opportunities of retail investors.
Given the history of setbacks the SEC has suffered in the DC Circuit, adopting climate rules that impose inflexible, prescriptive disclosure mandates that require data that are difficult and very costly to gather and are potentially confusing and even unhelpful to investors, would seem to well satisfy the APA’s test for arbitrary or capricious.
In their submitted comments to the SEC, many companies have pushed back on the prescriptive rules, suggesting a higher threshold than the proposed 1% in line items, which would bring the triggers for disclosure closer to material.
To comply with the APA, the SEC should consider the submitted comments, should thoughtfully evaluate proffered alternatives, and should provide a reasoned explanation in response. Adhering to the APA process will give the SEC its best chance to avoid any adopted rules being vacated by the DC Circuit.
(Bloomberg LP, parent company of Bloomberg Law, submitted a letter to the SEC supporting the proposed rules.)
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