Much has been said about Chair Gary Gensler's aggressive rulemaking since his arrival at the U.S. Securities and Exchange Commission in April 2021. Certainly, the number of rule proposals has increased: The SEC has proposed 69 rules since his arrival, versus 54 for his predecessor over a slightly longer period.[1]
But the more concerning issue, at least to Gensler's critics, is that the scope of the SEC's most controversial proposals would significantly expand SEC authority over hitherto unregulated areas of activity, yet the statutory authority for these expansions appears weak or nonexistent.
In particular, two of the most controversial rules would require climate-related disclosures by public companies and disclosures regarding environmental, social or governance, or ESG, factors by investment companies and registered investment advisers.
For 40 years, the standard of review for agency rulemaking was set forth in the 1984 case of Chevron U.S.A. Inc. v. Natural Resources Defense Council Inc.[2] In that case, the U.S. Supreme Court held that where a statute was silent or ambiguous with respect to a specific issue, courts would defer to the agency interpretation of the statute if the interpretation was based on a permissible construction of the statute. It was under the Chevron deference standard that these rule proposals were drafted.
Now, under the Supreme Court's June decision in Loper Bright Enterprises v. Raimondo,[3] federal courts will not defer to agency interpretations, likely spelling doom for the SEC's climate disclosure and ESG rules.
The Climate Disclosure Rule
The SEC issued its climate disclosure rule on March 6, and voluntarily stayed the rule on April 4. Originally proposed on May 9, 2022,[4] the rule would require public companies to provide climate-related disclosures in their registration statements and annual reports about climate-related risks that have materially affected or are reasonably likely to have a material impact on their business strategy, results of operations or financial condition.
The required information would include disclosures regarding the company's greenhouse gas emissions they generate or purchase — Scope 1 and Scope 2 — and the indirect emissions of entities from the company's supply chain — Scope 3.
The SEC asserted that:
Investors need information about climate-related risks — and it is squarely within the Commission's authority to require such disclosure in the public interest and for the protection of investors — because climate-related risks have present financial consequences that investors in public companies consider in making investment and voting decisions.[5]
The proposal received more than 24,000 comments.[6] Many industry comments focused on the burdens the rule would impose on companies and therefore the need for significant revisions to the proposal. Others focused on the SEC's alleged lack of statutory authority, whether it complied with the Administrative Procedure Act, and whether the rule violated the First Amendment or the major questions doctrine.[7]
On March 6, the SEC issued a more limited final rule removing some of the more burdensome requirements, such as the Scope 3 requirement to disclose emissions of those in the company's supply chain, while adding certain exemptions from Scope 1 and 2 requirements for smaller reporting companies and emerging growth companies.
Litigation
Litigation quickly ensued. Multiple parties, including a total of 25 states, filed petitions for review in the U.S. Courts of Appeals for the Second Circuit, Fifth Circuit, Sixth Circuit, Eighth Circuit, Eleventh Circuit and District of Columbia Circuit. On March 21, the Judicial Panel on Multidistrict Litigation selected the U.S. Court of Appeals for the Eighth Circuit to hear all nine lawsuits.
Although the petitioners raise many challenges, the claim regarding the lack of statutory authority is likely dispositive.
On April 4, the SEC issued an order staying the rule "pending the completion of judicial review of the consolidated Eighth Circuit petitions."[8]
Lack of Statutory Authority
The SEC is most vulnerable to a challenge regarding its authority to issue such a rule. Indeed, the statutory authority cited in support — Sections 7, 10, 19(a) and 28 of the Securities Act of 1933, and Sections 3(b), 12, 13, 15, 23(a) and 36 of the Securities Exchange Act of 1934 — only sets forth the authority of the SEC to require, in a registration statement or prospectus, "such other information ... as the Commission may by rules or regulations require as being necessary or appropriate in the public interest or for the protection of investors."[9]
While the sections clearly grant the SEC the power to issue disclosure rules about information related to a company's value and prospects for financial success, financial statements, core business information, information about directors and management, and a description of the securities being sold, they are silent regarding climate-related risks.
After Loper Bright, no deference should be given by the courts to the SEC's interpretation of its own authority under the acts. Instead, the courts will look to the text and context of the statutes.
According to the Supreme Court's 2022 decision in West Virginia v. U.S. Environmental Protection Agency, "[i]t is a fundamental canon of statutory construction that the words of a statute must be read in their context and with a view to their place in the overall statutory scheme," quoting its 1989 decision in Davis v. Michigan Department of Treasury.[10]
In West Virginia v. EPA, the court also said "that inquiry must be 'shaped, at least in some measure, by the nature of the question presented' — whether Congress in fact meant to confer the power the agency has asserted," quoting its 2000 opinion in U.S. Food and Drug Administration v. Brown & Williamson Tobacco Corp.[11]
Legislative History
There is no evidence in the cited statutory authority that Congress has conferred any authority to the SEC to require climate-related disclosures. Nor is there any evidence in the legislative history. Instead, the history demonstrates Congress' express intent to limit the SEC's discretion regarding the disclosures it could elicit.
For example, the 1933 U.S. House of Representatives committee report[12] regarding the proposed Securities Act indicates the relevant delegation of power was limited to the enumerated disclosures: "To assure the necessary knowledge for [an investor's] judgment, the bill requires enumerated definite statements [in a registrant's disclosures]. Mere general power to require such information as the Commission might deem advisable would lead to evasions, laxities, and powerful demands for administrative discriminations."[13]
And the 1934 House committee report regarding the proposed Exchange Act states the committee specified the disclosures to register a security on an exchange under Section 12 of the Exchange Act because it did not want to give too much disclosure discretion to the SEC. The SEC was not to have "unconfined authority to elicit any information whatsoever."[14] Consistent therewith, the Exchange Act provides only a limited ability for the SEC to add disclosure items.
Since passing the Securities Act and Exchange Act, the SEC has consistently taken a narrow view of its authority to compel environmental or social disclosures. For example, in 1975, after Congress passed the National Environmental Policy Act requiring agencies to consider the promotion of environmental values and protection as a factor when making decisions — but not providing statutory authority for any new climate-related disclosures — the SEC stated, "it is generally not authorized to consider the promotion of social goals unrelated to the objectives of the federal securities laws."[15]
Further, that:
the discretion vested in the Commission under the Securities Act and the Securities Exchange Act to require disclosure which is necessary or to consider appropriate "in the public interest" does not generally permit the Commission to require disclosure for the sole purpose of promoting social goals unrelated to those underlying these Acts.[16]
In sum, the SEC's disclosure authority was limited to requiring information about the financial condition of and matters of economic significance to the disclosing company.[17]
While it is true that the SEC has adopted certain rules requiring public companies to disclose generally the material risk factors affecting the company[18] and the material effects (i.e., upon expenditures and earnings) that compliance with environmental regulations might have,[19] these rules relate to existing risk factors and costs affecting the company. They do not provide authority for prescriptive rulemaking requiring disclosure of potential prospective risks.
Finally, in 2016, the SEC reiterated its earlier position:
In 1975, the Commission considered a variety of "environmental and social" disclosure matters, as well as its own authority and responsibilities to require disclosure under the federal securities laws. Following extensive proceedings on these topics, the Commission concluded that it generally is not authorized to consider the promotion of goals unrelated to the objectives of the federal securities laws when promulgating disclosure requirements, although such considerations would be appropriate to further a specific congressional mandate.[20]
Nothing has changed since the SEC issued the above guidance in 2016. As a result, the SEC's policy arguments made and the authorities cited in its climate disclosure rule release are insufficient because they are not supported by the text or the legislative history of either the Securities Act or the Exchange Act.
Under Chevron, it is a barely colorable argument that the rule was based on a permissible construction of authority set forth in the Securities Act or the Exchange Act. Under Loper Bright, however, it is not even colorable. The Eighth Circuit will likely vacate the rule.
The ESG Rule
The SEC proposed an even broader rule for investment funds, the ESG rule,[21] on May 25, 2022, but has not yet finalized the rule. The SEC may be waiting to see whether it is able to successfully implement the climate disclosure rule before issuing the final ESG rule.
As proposed, the ESG rule would require registered investment advisers, registered investment companies and business development companies to provide information regarding ESG investment practices. The proposal sets forth a three-tier spectrum of disclosures for funds that:
- Use ESG factors in investment decisions, but not in a significant way;
- Have a name suggesting an ESG focus or focus on ESG factors by using them as a significant or main consideration; and
- Are ESG-focused and also seek to achieve a specific
The extensive disclosures must be made not only in prospectuses but also in annual reports and adviser brochures. And most burdensome, the proposal required the funds to provide aggregated emissions data for the entire portfolio.
In support, the SEC asserts that:
While the Commission has not generally prescribed specific disclosures for particular investment strategies, ESG strategies differ in certain respects that we believe necessitate specific requirements and mandatory content to assist investors in understanding the fundamental characteristics of an ESG fund or an adviser's ESG strategy in order to make a more informed investment decision.[22]
Lack of Statutory Authority
Although there are several possible challenges to the proposed rule if it were to become finalized, the SEC would be most vulnerable to the same challenge facing its climate disclosure rule — that it lacks the statutory authority to issue the ESG rule.
Indeed, the statutory authority the SEC cites in support of the ESG rule under the Investment Advisers Act of 1940 and the Investment Company Act of 1940 is substantively the same authority the SEC cites in support of the climate disclosure rule, supra.
Specifically, the SEC cites to Sections 8, 24, 30 and 38 of the Investment Company Act, and Sections 203, 204 and 211 of the Investment Advisers Act,[23] which set forth the authority of the SEC to require from investment companies and investment advisers such information, records and documents as the commission shall by rules or regulations prescribe "as necessary or appropriate in the public interest or for the protection of investors."[24] This may include material information on investment objectives, strategies, risks and governance, but there is no mention of ESG practices.
But courts — including the D.C. Circuit in Business Roundtable v. SEC in 1990 — have specifically told the SEC that "'public interest' is never an unbounded term," but is instead "limited to 'the purposes Congress had in mind when it enacted [the] legislation." The two acts are entirely silent, however, regarding any requirements for environmental, social or governance-related information.
Legislative History
The Investment Company Act and the Investment Advisers Act were designed to "eliminate certain abuses in the securities industry, abuses which were found to have contributed to the stock market crash of 1929 and the depression of the 1930's," according to the Supreme Court in SEC v. Capital Gains Research Bureau Inc. in 1963. Such abuses included misrepresentations, manipulations and fraud.
The "essential purpose of [the acts] is to protect the public from the frauds and misrepresentations of unscrupulous tipsters and touts," according to a 1940 House report discussing the two acts.[25]
Nothing in either act suggests an intent to require registered investment advisers, registered investment companies and business development companies to provide information regarding their ESG practices, if any, to the SEC as opposed to protecting the public from fraudsters.
Thus, despite the SEC's policy arguments in its release for the proposed ESG rule, the authority it cites is insufficient. The proposed rule is not supported by the text or the legislative history of either the Investment Company Act or the Investment Advisers Act.
In sum, under Chevron, there may not be even a colorable argument that the ESG rule proposal is based on a permissible construction of the cited statutory authority. And under Loper Bright, without any deference to the SEC's interpretation, the ESG rule proposal, if it is finalized, will likely be found lacking in statutory support and vacated by the courts.
Reprinted with permission from Law360.
[1] https://www.sec.gov/rules-regulations/rulemaking-activity?search=&rulemaking_status=All&division_office=All&year=All&page=6; https://www.sec.gov/about/sec-commissioners/sec-historical-summary-chairmen-commissioners. Mr. Gensler has served since April 19, 2021. Jay Clayton served from May 14, 2017, to December 23, 2020.
[2] Chevron, U.S.A., Inc. v. Natural Resources Defense Council, Inc.,104 S.Ct. 2778 (June 25, 1984).
[3] Loper Bright Enterprises v. Raimondo, 144 S.Ct. 2244 (June 28, 2024).
[4] SEC, The Enhancement and Standardization of Climate-Related Disclosures for Investors (S7-10-22) (May 9, 2022); https://www.sec.gov/rules-regulations/2024/03/s7-10-22#33-11061proposedd
[5] Id., p. 9.
[6] https://www.mcguirewoods.com/client-resources/alerts/2024/3/sec-adopts-final-rules-on-climate-related-disclosures/#:~:text=The%20Final%20Rules%20provide%20for,material%20impacts%20o%20n%20the%20registrant.
[7] https://corpgov.law.harvard.edu/2022/11/23/review-of-comments-on-sec-climate-rulemaking/.
[8] https://www.sec.gov/files/rules/other/2024/33-11280.pdf.
[9] See, e.g., https://www.law.cornell.edu/uscode/text/15/77g and https://www.law.cornell.edu/usc%20ode/text/15/78l.
[10] West Virginia v. EPA, 597 U.S. 697, 721 (2022).
[11] Id., citing FDA v. Williamson Tobacco Corp., 529 U.S. 120, 159 (2000).
[12] H.R. Rep. No. 73-85 (1933).
[13] Id. at 7.
[14] H.R. Rep. No. 73-1383, at 23 (1934).
[15] SEC, Environmental and Social Disclosure, 40 Fed. Reg. 51656 (Nov. 6, 1975).
[16] Id. at 51660.
[17] Id. at 51658.
[18] E.g., 17 CFR 229.105(a); see also Adoption of Integrated Disclosure System, Release No. 33-6383 (Mar. 16, 1982).
[19] See 17 CFR 229.101(c)(2)(i); Adoption of Disclosure Regulation and Amendments of Disclosure Forms and Rules, Release No. 33-5893 [42 FR 65554, 65562 (Dec. 30, 1977)] ("Appropriate disclosure shall also be made as to the material effects that compliance with Federal, State and local provisions which have been enacted or adopted regulating the discharge of materials into the environment, or otherwise relating to the protection of the environment, may have upon the capital expenditures, earnings and competitive position of the registrant and its subsidiaries").
[20] SEC, Business and Financial Disclosure Required by Regulation S-K, 81 Fed. 23916, 23971 (Apr. 22, 2016) (concept release) (footnote omitted).
[21] SEC, Enhanced Disclosures by Certain Investment Advisers and Investment Companies About Environmental, Social, and Governance Investment Practices (S7-17-22) (May 25, 2022).
[22] Id. at 17.
[23] The SEC also cites to sections 5, 6, 7, 10, and 19 of the Securities Act, and sections 13, 15, 23, and 35A of the Exchange.
[24] See, e.g., https://www.law.cornell.edu/uscode/text/15/80a-8 and https://www.law.cornell.edu/uscode/text/15/80b-4.
[25] H.R. Rep. No. 2639, 76th Cong., 3d Sess. 28 (1940).
