Last week, a majority of the commissioners of the Securities and Exchange Commission (SEC) voted to approve a comprehensive package of rule changes that would require public companies to report detailed information on climate-related risks and greenhouse gas emissions. The move was no surprise: in July 2021, SEC chairman Gary Gensler said that “investors increasingly want to understand the climate risks of the companies whose stock they own or might buy,” and that “consistent, comparable, and decision-useful disclosures” could help. Defenders of the proposed changes argue that mandatory and consistent climate-related disclosures must be applied to public companies, given the existential and company-specific risks associated with climate change. Critics advance concerns about the cost of such compliance, regulatory overreach, and mission creep at the SEC—a Depression-era regulatory agency originally established to protect investors. That last contention gives critics the better argument.
Start with the agency’s origins. The SEC was founded to enforce the Securities Act of 1933 and the Securities Exchange Act of 1934, which Congress passed to protect investors from fraud (common at the time) and to create a uniform, national regulatory regime for the placement and secondary trading of securities. The SEC defines its mission as “protecting investors, facilitating capital formation, and maintaining fair, orderly and efficient markets.”
The SEC has promulgated rules and promoted legislation to advance these objectives. These include regulations to address selective disclosure of nonpublic information; rules related to false statements, deceptive practices, and insider trading; and the Private Securities Litigation Reform Act of 1995, which created a safe harbor for companies making forward-looking statements. Along with the financial reporting required of public registrants, this legal and regulatory regime serves to provide investors with protections and disclosure requirements that benefit both issuers and buyers of securities.
Enter the proposed climate-related disclosures. These come at a time when certain large institutional investors believe that companies’ currently voluntary climate-related filings should follow uniform standards, and when investment-advisory and corporate fiduciaries are increasingly fond of enacting climate policy through mandates on the private sector. And they’re consistent with a larger advocacy effort to encourage the application of environmental, social, and governance (ESG) principles to investors’ appraisal of companies.
While more information tends to be a good thing, any mandatory disclosure requirement imposed on firms should be evaluated against three considerations: the cost of providing such information, the expertise of the agency implementing the mandate, and the relevance of the information. In this case, it’s reasonable to suppose that the benefit might indeed outweigh the cost, and the SEC would have no trouble securing expertise. But the information bears little relevance to the SEC’s statutory mission.
A 500-page document details a host of changes that generally fall into one of two categories—the risk that climate change poses to the disclosing company, and the effect the disclosing company has on climate change. Each is problematic for different reasons.
Uniform disclosures about the impact of climate on companies are superficially reasonable. Public-company disclosure obligations were designed, after all, to assess the material risks that may threaten a company’s operations, financial performance, or existence. But the proposed rules fail to distinguish between macro and micro climate risks. For example, the SEC’s press release states that the proposed changes would require firms to disclose “how any climate-related risks identified by the registrant have had or are likely to have a material impact on its business and consolidated financial statements, which may manifest over the short-, medium-, or long-term.” The same formulation could, in theory, mandate disclosure of the risks of future thermonuclear conflict, solar flares, or viral pandemics. Such information is so general and far-reaching as to be effectively meaningless for assessing the risks to a specific company.
Meantime, the proposed “Scope 1” and “Scope 2” rules—which relate to the effects a company has on the climate—would require SEC registrants to disclose their own greenhouse gas emissions and those of other parts of the value chain. The goal, the SEC says, is “to assess a registrant’s exposure to, and management of, climate-related risks, and in particular transition risks.” But this assumes facts not in evidence. The notion of an inevitable “energy transition” may be championed by policymakers and opinion leaders, but it’s not foreordained. When and whether an ultimate transition away from carbon-based fossil fuels to renewable energy sources will happen is unknowable, rendering such disclosures wholly speculative. Any disclosures would be more reflective of progressive aspirations than of material, foreseeable risks from existing or contemplated regulation or law. The press release notes that “the proposed disclosures are similar to those that many companies already provide based on broadly accepted disclosure frameworks, such as the Task Force on Climate-Related Financial Disclosures and the Greenhouse Gas Protocol”—neither of which has the force of law.
Investors and fiduciaries should be concerned with the risks to the enterprises they assess for possible investment. A company’s cost structure, compliance with law and regulation, competitor behavior, and major threats are all relevant. Yet lawful activities may affect the climate without affecting its performance or prospects, and the possibility that such activities could be prohibited by future environmental regulation is an uncertain, over-the-horizon possibility that investors and fiduciaries can’t bank on.
Requiring public companies to make such disclosures imposes costs without creating the benefits associated with protecting investors, facilitating capital formation, and assuring orderly markets. Such mission creep risks diverting the agency’s attention from ensuring that the public has enough information to make informed decisions—and further blurs the line between public policy and the private sector’s fiduciary obligations.
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