The SEC’s Climate-Risk Disclosure Rule is not novel. And that’s a good thing.
Investing is about predicting the future. If I buy stock today, will it give me a return next year? In five years? Ten? In assessing their options, an investor might want to know, whether a property management company has all of its assets in flood-prone areas. Or how mounting heat waves are affecting an agricultural firm’s crop productivity. An investor probably also wants to know what, if anything, a company is doing to identify and manage these kinds of risks. That’s where the Securities and Exchange Commission (SEC) comes in.
Coming onto the scene just five years after sliced bread, the SEC has nearly ninety years of experience creating disclosure requirements that give investors the information they need in order to decide where to invest their money. In response to investor demand, the Commission recently proposed a rule that would require publicly traded companies to share information about their exposure to climate-related financial risks. Climate risks can be physical risks (think floods, wildfires, and extreme heat) or transition risks (changing policy or market landscapes as we work to mitigate climate change). The proposed rule would require companies to disclose the costs they are already facing from physical and transition risks, their strategies and structures for identifying and managing such risks, and their greenhouse gas emissions. Emissions are included because they are a useful proxy for estimating how a company might be affected by transition risks from a changing energy market.
This common-sense rule is not without controversy. SEC Commissioner Hester Peirce wrote a lengthy, scathing dissent of the proposal, and some conservative securities professors have attacked the rule as outside the Commission’s authority. Many of these criticisms take a two-pronged attack. First, they claim climate-related information is outside the SEC’s purview. Second, they attack specific features of the proposed rule. In particular, they argue the proposed rule breaks from the SEC’s traditional understanding of materiality and that it sets unreasonable requirements for the consideration of uncertain future risks.
These critiques are attempting to frame the Commission’s authority to promulgate climate-related disclosures as a “major question” that would require explicit authorization from Congress. The “major questions doctrine” is an ill-defined interpretive framework that courts have applied when an agency uses its powers to address issues of vast economic and political significance in a novel way that transforms the agency’s regulatory authority. If a policy presents a “major question,” this framework suggests that a court should look to whether Congress explicitly spelled out that authority.
In other words, if this doctrine were applicable to the climate-risk disclosure rule, it would arguably move the goalposts from, “is this rule within the SEC’s authority?” to, “did Congress specifically write about climate change in the Securities Act of 1933 or the Securities Exchange Act of 1934?”
Since the Supreme Court applied the major questions doctrine in an important climate decision a few weeks ago, critics of the proposed rule have been arguing that it is relevant here too. But the climate-risk disclosure rule is clearly outside of the scope of the major questions doctrine. Far from being transformative or extraordinary, the SEC’s proposed rule is a run-of-the-mill use of the SEC’s authority with ample precedent. My colleagues and I waded through over sixty years of SEC regulatory precedents to prove it. (We detail our findings in these comments, jointly filed by the Institute for Policy Integrity at New York University School of Law, Environmental Defense Fund, and Professor Madison Condon at Boston University School of Law.) The major questions doctrine is not applicable.
Climate topics are fair game for the SEC
One of Commissioner Peirce’s made-for-talk-radio arguments is that the SEC may not require climate-related disclosures because it is “not the Securities and Environment Commission.” But the SEC has required environmental disclosures for half a century, without issue, so it is unclear why venturing into climate-related disclosures would be any different. If merely exercising its disclosure authority in a given topic area is enough to transform (and retitle) the SEC, the “Securities and Environment Commission” moniker will have to get in line.
The Commission has required disclosures across a wide array of topics that might look non-financial on their face, but that are nonetheless financially relevant for investors because they shed light on investment risk. Consider, for example, disclosures on extractive resources, raw materials availability, executive compensation practices, and detailed governance disclosures. For decades, governance disclosures have even included information meant to inform investors about the competency and integrity of officers. Surely, requiring disclosures that are associated with an officer’s integrity did not transform the SEC into the Securities and Ethics Commission?
The Commission has regulated in all of these areas without specific direction from Congress; in other words, it has used its general disclosure authority under the Securities and Exchange Acts, the same authority it is using to promulgate climate-related financial risk disclosures today.
The SEC has never limited itself to only material disclosures
Disclosures can generally be divided into two types: principles-based disclosures and rules-based (or prescriptive) disclosures. Principles-based disclosures require companies to disclose information only when it is material. According to the Supreme Court, a piece of information is material if there is a “substantial likelihood” that a reasonable investor would find that the information changes the “total mix” of available information. Rules-based disclosures, on the other hand, apply to everybody. For example, a rules-based disclosure might directly ask for the number of employees, while a principles-based disclosure would ask a company to describe material aspects of its workforce. Given that Commissioner Peirce has argued that a company’s number of employees is not necessarily material, under a principles-based disclosure, some companies might include it, and others might not. A principles-based regime can make it hard for investors to compare companies to each other.
While the proposed rule uses a principles-based approach in some places (such as when asking a company what material climate risks it anticipates), it uses a more comparable rules-based approach in others (such as when asking companies to disclose the realized costs of extreme weather). In her dissent, Commissioner Peirce argues that the SEC should only require climate disclosures that are “universally material.” That is, the SEC should only require disclosures that would be material for every single company required to make that disclosure.
The SEC has never confined itself to such an extraordinarily limited interpretation of its authority.
In fact, rules-based disclosures have been common throughout the SEC’s history. To name a handful: disclosures on stock buybacks, board attendance policies, nominating committee processes, and procedures for approving related-party transactions. In other cases, the SEC has set a threshold for disclosure — e.g. requiring disclosure if the item is above a certain percent of a company’s assets or a certain dollar threshold. These threshold disclosures can also be found scattered throughout SEC regulations, including: disclosures regarding excise taxes, perquisites and personal benefits to executive officers and managers, and environmental proceedings that include a government party. To be clear, the Commission does not view setting a threshold as functionally equivalent to a materiality finding; as recently as 2020, it explained that, “a single numerical threshold may result in some disclosures that are not material.” In other words, if universal materiality were actually a requirement, a good portion of the SEC’s current disclosure framework would be defunct.
Even people who like principles-based approaches recognize that rules-based standards can be helpful. In 2020, the SEC instituted major revisions to its disclosure framework in order to move to a more principles-based approach. These revisions ultimately retained a rules-based threshold for when a company would have to disclose that it was subject to environmental proceedings. The rationale? “[U]se of a materiality standard . . . could result in large registrants providing less disclosure.” Even for commissioners with a great love for principles-based disclosures, the inclusion of some immaterial information was a feature, not a bug.
The SEC can ask (and has asked) companies to look towards the future
Commissioner Peirce also attacks the proposed rule because it would require companies to assess uncertain future risks. But consideration of future risks has been part of SEC regulations for decades. The SEC’s Management Discussion & Analysis (MD&A) disclosures have long required a discussion of “known trends, events, and uncertainties” that could have material effects on a company. Physical risks from climate change, while subject to prediction error, certainly reflect known trends. As do transition risks; thirteen U.S. states and forty countries are subject to an emissions market or carbon tax, while twenty-three U.S. states or territories have zero-emissions goals. These commitments already affect the market.
Even if, however, you mistakenly think transition risks are, as Commissioner Peirce says, “rooted in prophecies of coming . . . action,” the proposed rule would still be well-supported by analogous prior actions by the SEC. For one, market risk disclosures — created in 1997 — ask for information about how a company would be affected by “reasonably possible” market changes. The SEC has explicitly clarified that these disclosures extend a step further than the risks covered by the MD&A. Outside the regulatory context, the SEC has also used guidance to specify when companies should disclose information about third-party or governmental actions. When the Euro was being adopted, the SEC even asked companies to consider whether and how they might be affected by their competitors consolidating their operations across European markets. There is nothing novel about asking companies to disclose how they may be affected by future changes in the market, competition, or policy landscape, even if the precise nature of those changes is uncertain.
The SEC’s proposed rule is not novel or unique, but well-centered within the constellation of prior SEC regulations. Indeed, it seems the proposed rule is largely coming under fire because it has the misfortune of containing the word “climate” in its title and description. Perhaps the SEC should rechristen the proposed rule “Disclosures regarding exposure to extreme weather and changing energy markets.” It would doubtless be less controversial.
