By Troy Fowler
SEC – Securities and Environment Commission?
In 1933, President Franklin Delano Roosevelt signed the Securities Act (’33 Act), federalizing securities law in wake of the devastation of the United States’ financial system brought on by the Stock Market Crash of 1929. The ’33 Act was followed shortly thereafter by the Securities Exchange Act (’34 Act) which established the Securities Exchange Commission (SEC) as the purveyor of US securities laws. While the two acts govern different aspects of securities law, they share one common method for achieving their goals: disclosure. By increasing investor transparency into the material financial risks around investments, and by establishing laws that proscribe misrepresentation and fraudulent activities by issuers, the federal securities laws can be boiled down to having been purposed to elicit honest financial disclosures.
Companies that are subject to disclosure requirements must file an initial registration statement followed by periodic quarterly and yearly reports with the SEC. They must include therein any of the line items required by Regulation S-K. Among other things, companies must disclose any material changes to previously disclosed risks as well as identify any new material risks to the business. They are subject to liability for any material misstatements or omissions in their registration statement or any of their periodic filings.
One thing that has been clear since the conception of Reg. S-K is that materiality forms the basis for the disclosure requirement. When the SEC tasked Commissioner Francis M. Wheat with the study that ultimately led to the adoption of Reg. S-K, it indicated that Wheat’s study was intended to “improv[e] the … dissemination to the investing public of information material to investment decisions.” The materiality standard has been clarified through caselaw and is considered a mixed question of law and fact. The Supreme Court has instructed that information is “material” when a reasonable investor would view its omission or misstatement as having significantly altered the “total mix” of information available. According to the Court, materiality “will depend at any given time upon a balancing act of both the indicated probability that the event will occur and the anticipated magnitude of the event in light of the company activity.”
In March, the SEC promulgated a final rule which, if enacted, would add to the litany of required disclosures a category lacking any tenable connection whatsoever to financial regulation: Environmental, Social, and Governance (ESG) disclosures. I will focus on the environmental aspect of the proposed rules. The SEC has the authority to enact disclosure requirements that are “necessary or appropriate in the public interest or for the protection of investors.” The proposed climate disclosures are as unnecessary as they are antithetical to the SEC’s stated purpose of protecting investors. The existing disclosure regime is sufficient to address any such issues and it is far from clear that investors—as opposed to non-investor stakeholder activists—wish for or require any such protections.
The proposed climate-related provisions under Reg. S-K would require disclosure of a registrant’s: governance of climate-related risks; any material climate-related impacts on its strategy, business model, and outlook; climate-related risk management; GHG emissions metrics; and climate-related targets and goals, if any. The proposed rule would require disclosure of both “physical” and “transition” risks from climate-change, effectively imposing presumptive materiality upon anything climate related. The climate disclosures are split into three categories: financial impact metrics; expenditure metrics; and financial estimates and assumptions. The SEC claims that these financial metrics have the objective of increasing transparency around how climate-related risks impact a registrant’s financial statements. It justifies tacking these climate disclosure rules onto Regulations S-K and S-X “because the required disclosure is fundamental to investors’ understanding of a registrant’s business and its operating prospects and financial performance ….”
The issue is that “[c]ompanies should [already] be disclosing material risks under our current rules. If ESG opportunities are driving management-decision making, our existing disclosure rules also pull those in.” According to William Hinman, the director of the SEC’s Division of Finance, a principles-based disclosure requirement such as materiality “articulate[s] an objective and look[s] to management to exercise judgment in satisfying that objective by providing appropriate disclosure when necessary.” He further explained that “[t]he flexibility of our principles-based disclosure requirements should result in disclosure that keeps pace with emerging issues, … without the need for the Commission to continuously add to or update the underlying disclosure rules as new issues arise.”
Among the “transition risks” that companies would be required to disclose are “actual or potential negative impacts on a [company’s] consolidated financial statements, business operations, or value chains attributable to regulatory, technological, and market changes to address the mitigation of, or adaptation to, climate-related risks.” Specifically, it states that such risks would include “increased costs attributable to climate-related … competitive pressures associated with the adoption of new technologies.”
The financial markets react to business news every day. In fact, baked into the current understanding of securities laws is the notion that in an efficient capital market, all information known to the public affects the price and thus every investor. Good businesses prosper, bad businesses fail. The father of modern economics, Adam Smith, stated, “The real and effectual discipline which is exercised over a workman is … that of his customers. It is the fear of losing their employment which restrains his frauds and corrects his negligence.” Thus, the “competitive pressures” the SEC cites as a potential cause for transition risk should already pressure companies into making ESG disclosures—if investors really cared. Commissioner Hester M. Pierce believes that non-investor stakeholder activists are those for whom these proposed rules are truly intended:
Current … disclosure mandates are intended to provide investors with an accurate picture of the company’s present and prospective performance through managers’ own eyes. … The proposal, by contrast, tells corporate managers how regulators, doing the bidding of an array of non-investor stakeholders, expect them to run their companies. … It forces investors to view companies through the eyes of a vocal set of stakeholders, for whom a company’s climate reputation is of equal or greater importance than a company’s financial importance.
Two recent Deloitte studies indicate that although 92% of respondents saw a need for their companies to “invest more in technology to address demand for consistent and reliable measurement, reporting and disclosures,” 25 out of 26 companies from diverse practice areas stated that climate change is not yet material. In fact, the only one that did say it was material was already disclosing it on its 10-K. In other words, the content of a company’s current voluntary ESG disclosures, or lack thereof, forms part of the basis for that firm’s stock price. Recent studies suggest that companies choosing to voluntarily disclose climate risks achieve a higher valuation post-disclosure. Competitive pressures arising from other companies adopting more progressive models may or may not induce managers to adopt the sort of new technologies the SEC envisions will constitute costly “transition risks,” but at the very least the market will judge those firms and their value will be adjusted accordingly.
To further support transition risk disclosures, the proposed rule also cites “reputational impacts (including those stemming from a registrant’s customers or business counterparties) that might trigger changes to market behavior.” Commissioner Allison Herron Lee’s argument that regulation is needed because firms have incentives to hide material risks as they compete for capital “simply is not correct: Firms are long-lived entities, at least in principle, meaning that their long-run interest is served by preservation of their credibility.” Commissioner Lee fails to consider that market forces may compel companies to voluntarily adopt measures to achieve these results. Companies respond to issues that further their incentives. Preserving their credibility by offering full and truthful material information to the market is the most prudent way to ensure their customers and business counterparties come back for more.
Additionally, climate risks might simply be too far off in the future for financial disclosures—based on materiality—to be the appropriate governing mechanism. Even an “application of the Environmental Protection Agency climate model strongly suggests that climate policies, whether implemented by the U.S. government alone or as an international cooperative policy, would have temperature effects by 2100 that would be virtually undetectable or very small.” That notwithstanding, assume we use 2100 as the threshold past which climate change must be addressed, as many scientific studies do. The issue is that no prudent corporate manager can plan intelligently past 5-10 years. “No board meeting in 1942 could have predicted the future development and importance of the integrated circuit—much less the chip shortage currently impacting the auto, appliance, and aerospace sectors.” “[B]anks did not fail in 2008 because they bet on radios not TV in the 1920s. [They] failed over mortgage investments made in 2006. Trouble in 2100 will come from investments made in 2095,” at least as far as businesses are concerned. If the idea is to set environmental policy, leave that to the EPA or Congress, the SEC should not mask it as financial regulation.
“The campaign for evaluation and disclosure of climate ‘risks’ by public companies is an obvious effort to use private-sector resources for ideological purposes, in the context of the unwillingness of the Congress to enact such policies explicitly.” The proposed SEC rules do not serve to better inform the market: stocks are already priced based on all available information. Rather, the SEC seeks to use the new rules to compel companies to adopt new technologies because the appropriate avenue for bringing about environmental change—legislation by elected bodies subject to political accountability—has failed or otherwise proven unwilling to pass any substantive climate legislation. Otherwise, this is “climate activism in finance-regulation drag.” “[F]inancial regulators are not allowed to ‘mobilize’ the financial system, to choose projects they like and de-fund those they disfavor.” “A mandate from the SEC that public companies evaluate climate ‘risks’ is likely to distort the allocation of capital away from economic sectors disfavored by certain political interest groups pursuing ideological agendas.” If the materiality standard is to bear any weight, the proposed SEC rules should not be implemented.
 Hester M. Pierce, We are Not the Securities and Environment Commission – At Least Not Yet, SEC (Mar. 21, 2022), https://www.sec.gov/news/statement/peirce-climate-disclosure-20220321?utm_medium=email&utm_source=govdelivery [https://perma.cc/B5WU-9TGZ].
 Andrew Beattie, The SEC: A Brief History of Regulation, Investopedia (Feb. 3, 2022), https://www.investopedia.com/articles/07/secbeginning.asp [https://perma.cc/2BQT-QXJQ].
 The Laws That Govern the Securities Industry, Investor.gov, https://www.investor.gov/introduction-investing/investing-basics/role-sec/laws-govern-securities-industry#:~:text=Often%20referred%20to%20as%20the,in%20the%20sale%20of%20securities [https://perma.cc/AA5L-9FWB].
 See 15 U.S.C. § 77e.
 See 15 U.S.C. §§ 78m, 78o.
 See id.; see generally 17 C.F.R. § 229.
 See 17 C.F.R. §§ 229.101, 229.105.
 See 17 C.F.R. § 240.10b-5.
 Hester M. Pierce, Comm’r, Sec. Exchange. Comm’n., Speech at the Brookings Institution: What Role Should the SEC Play in ESG Investing? (July 20, 2021).
 Announcement of Disclosure Study, SEC Release (Nov. 27, 1967), http://3197d6d14b5f19f2f440-5e13d29c4c016cf96cbbfd197c579b45.r81.cf1.rackcdn.com/collection/papers/1960/1967_1127_SECRelease.pdf [https://perma.cc/Q4F4-JCVM] (emphasis added); see Pierce, supra note 11.
 TSC Indus. v. Northway, 426 U.S. 438, 450 (1976).
 Id. at 449.
 Basic Inc. v. Levinson, 485 U.S. 224, 238 (1988).
 Proposed 17 C.F.R. §§ 210, 229, 232, 239, & 249 (2022), available at https://www.sec.gov/rules/proposed/2022/33-11042.pdf [https://perma.cc/Y52W-9HML] [hereinafter Proposed SEC Rule]; Richard Morrison, Climate Change: The SEC Turns Up the Heat, National Review (Mar. 24, 2022, 6:30 AM), https://www.nationalreview.com/2022/03/climate-change-the-sec-turns-up-the-heat/ [https://perma.cc/2X8F-LMB7].
 See, e.g., 15 U.S.C. §§ 77g, 78l, 78m, & 78o.
 Proposed SEC Rule, supra note 16, at 52.
 Id. at 60–61.
 Morrison, supra note 16.
 Proposed SEC Rule, supra note 16, at 52.
 Id. at 53–54.
 Id. at 53–54.
 Pierce, supra note 11.
 William Hinman, Director, Sec. Exch. Comm’n Div. of Fin., Remarks at the 18th Annual Institute on Securities Regulation in Europe (Mar. 15, 2019), available at https://www.sec.gov/news/speech/hinman-applying-principles-based-approach-disclosure-031519 [https://perma.cc/X6J5-U6RT].
 Proposed SEC Rule, supra note 16, at 61.
 Id. at 62.
 Brian Beers, How the News Affects Stock Prices, Investopedia (Sept. 30, 2021), https://www.investopedia.com/ask/answers/155.asp [https://perma.cc/5FAH-GRP4].
 See Basic Inc., 485 U.S. at 247.
 Adam Smith, The Wealth of Nations 117 (Ernest Rhys ed., J.M. Dent 1937) (1776).
 Pierce, supra note 11.
 US Public Companies Prepare for Increasing Demand for High Quality ESG Disclosures, Deloitte (Mar. 14, 2022), https://www2.deloitte.com/us/en/pages/about-deloitte/articles/press-releases/us-public-companies-prepare-for-increasing-demand-for-high-quality-esg-disclosures.html [https://perma.cc/CM8W-HM4F].
 Nicola M. White, SEC Drops Hints About ESG Rule in Retorts to Vague Disclosures, Bloomberg Law (Mar. 18, 2022, 4:45 AM), https://news.bloomberglaw.com/financial-accounting/sec-scrutiny-of-big-companies-sheds-light-on-climate-priorities?context=search&index=0 [https://perma.cc/D9DU-T3DS].
 Competitive Enterprise Institute, Comment Letter on Request for Input from Commissioner Allison Herron Lee, Securities and Exchange Commission on Climate Risk Disclosure (June 11, 2021), available at https://cei.org/wp-content/uploads/2021/06/SEC_climate_disclosure_20210315_questions_for_consideration_20210611.pdf [https://perma.cc/C5ZL-F58X] [hereinafter CEI Comment].
 Proposed SEC Rule, supra note 16, at 62.
 Benjamin Zycher, The SEC’s Climate ‘Disclosure’ Gambit, National Review (Oct. 29, 2021, 6:30 AM), https://www.nationalreview.com/2021/10/the-secs-climate-gambit/ [https://perma.cc/Q3WG-8SQV].
 Benjamin Zycher, Response to Request for Input from Commissioner Allison Herron Lee, Securities and Exchange Commission on Climate Risk Disclosures 3–4 (June 10, 2021), https://www.sec.gov/comments/climate-disclosure/cll12-8904262-243681.pdf [https://perma.cc/X45S-CPDB].
 Id. at 12.
 See id. at 2.
 See id. at 3.
 CEI Comment, supra note 37.
 21st Century Economy: Protecting the Financial System From Risks Associated With Climate Change: Hearing 117-214 Before the S. Comm. on Banking, Housing, and Urb. Affairs, 157th Cong. 13 (2021) (Statement of John H. Cochrane, Senior Fellow, Hoover Institution, Stanford University).
 Benjamin Zycher, The SEC Demands a One-Size-Fits-All Climate ‘Risk’ Disclosure System, National Review: (Apr. 21, 2021, 6:30 AM), https://www.nationalreview.com/2021/04/the-sec-demands-a-one-size-fits-all-climate-risk-disclosure-system/ [https://perma.cc/C62G-UTV3].
 See Basic Inc. v. Levinson, 485 U.S. 224, 247 (1988).
 Zycher, supra note 40, at 14.
 Morrison, supra note 16.
 Cochrane, supra note 47.
 Zycher, supra note 40, at 13.
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