For 40 years, the standard of review for agency rulemaking was set forth in the U.S. Supreme Court’s 1984 decision in Chevron U.S.A. Inc. v. Natural Resources Defense Council Inc. Chevron held that when a statute is silent or ambiguous on a specific issue, courts should defer to the agency’s interpretation if it is based on a permissible construction of the statute. It was under the Chevron deference standard that the ESG rule proposal was drafted. Now, following the Supreme Court’s June 2024 decision in Loper Bright Enterprises v. Raimondo, federal courts will no longer defer to agency interpretations, casting a stormy future for the SEC’s pending ESG rule.
The ESG Rule Proposal
Shortly after proposing its climate disclosure rule for public companies, the SEC proposed a broader rule for investment funds to enhance disclosures regarding their environmental, social, and governance (ESG) investment practices. See “SEC Proposes Fund ESG Disclosure Channels: Different ESG Strategies Must Row in Their Lanes,” Expect Focus – Life, Annuity, and Retirement Solutions (August 2022). The rule has not been finalized, and the SEC may be waiting to see if it can first successfully implement the climate disclosure rule, which is currently stayed pending judicial review, before issuing a final version of the ESG rule.
As proposed, the ESG rule would require registered investment advisers, registered investment companies, and business development companies to provide information regarding their ESG investment practices. The proposal sets forth a three-tier spectrum of disclosures for: (1) funds that use ESG factors in investment decisions, but not in a significant way; (2) funds with names suggesting an ESG focus or focus on ESG factors by using them as a significant or main consideration; and (3) funds that are ESG-focused and seek to achieve a specific goal. These disclosures must be made not only in prospectuses but also in annual reports and adviser brochures. And most burdensome, the proposal requires the funds to provide aggregated emissions data for the entire portfolio.
In support, the SEC’s proposing release asserts:
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.
Lack of Statutory Authority
The strongest challenge to the ESG rule, as proposed, is that the SEC lacks the statutory authority to adopt it.
But following Loper Bright, courts will no longer defer to the SEC’s interpretation of its own authority under federal securities laws when that authority is unclear. Instead, to determine whether Congress in fact meant to confer a power that the agency has asserted, courts will look to the words of a statute in their context and with a view to their place in the overall statutory scheme.
The SEC cites sections 8, 24, 30, and 38 of the Investment Company Act of 1940 and sections 203, 204, and 211 of the Investment Advisers Act of 1940 as statutory authority for implementing the ESG rule. These sections grant the SEC the authority to require information, records, and documents deemed “necessary or appropriate in the public interest or for the protection of investors.” However, these provisions do not mention the types of ESG practices contemplated by the proposed rule. And courts have specifically cautioned the SEC against interpreting “public interest” too broadly. For example, in Business Roundtable v. SEC (1990), the D.C. Circuit emphasized that “‘public interest’ is never an unbounded term” and that SEC rulemaking is “limited to the purposes Congress had in mind when it enacted the legislation.”
Legislative History
The legislative history of the Investment Company Act and the Investment Advisers Act describes an extraordinarily large number of problems and types of problems that those acts were designed to address. This history includes, for example, a massive four-year congressionally mandated investment trust study and related multivolume report by the SEC that formed the basis of lengthy and comprehensive congressional hearings leading up to the acts’ passage. But nothing in the legislative history, or in the text of either act, could fairly be interpreted as reflecting congressional intent to authorize the SEC to adopt the types of requirements contained in the proposed ESG rule. Thus, despite the SEC’s policy arguments, the authority it cites appears insufficient.
Significantly, in 1975, after Congress passed the National Environmental Policy Act of 1969 requiring agencies to consider environmental values in decision-making (but not providing statutory authority for climate-related disclosures), the SEC proposed a new rule regarding environmental and social disclosures, stating that “it is generally not authorized to consider the promotion of social goals unrelated to the objectives of the federal securities laws.”
The SEC reiterated this position in a 2016 concept release on business and financial disclosure under Regulation S-K:
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.
Nothing has changed since the SEC issued this guidance in 2016. As a result, despite the SEC’s policy arguments in its ESG rule proposal, its cited authority appears insufficient, as it is not supported by the text or legislative history of the Investment Company Act or the Investment Advisers Act. Moreover, the SEC itself indicated as recently as 2016 that it did not believe it had the authority to make such a rule.
In sum, under Chevron, there may have been a colorable argument that the ESG rule proposal is based on a permissible construction of the cited statutory authority. But under Loper Bright, without any deference to the SEC’s interpretation, this argument appears untenable. The ESG rule proposal, if finalized in its current form, will likely be vacated by the courts.
