Part 1: Reasons a Court Should Find that the SEC Lacked Legal Authority for the Climate-Change Disclosure Rules
Part 1 of a 4-part series
An administrative agency’s legal right to adopt regulations having the force of law is a sensitive area within the structure of the federal government. When the Securities and Exchange Commission announced a plan to enter the climate change area, it therefore raised questions about the agency’s legal authority. The SEC, the securities regulator? Not the Environmental Protection Agency?
Yes, the SEC. It proposed rules to compel climate-change disclosures from certain companies and invited comments from the public. Many commenters addressed the agency’s legal power to adopt such rules, and the submissions took different positions. My opinion was that the SEC did not have the power to adopt the rules it proposed. The comment on authority I submitted to the SEC during the rulemaking, which has some details not in this post, is here.
The SEC disagreed and adopted final disclosure rules on climate change in March 2024. The final rules are somewhat narrower than the proposed rules but still create a detailed and extensive special disclosure regime about climate change for companies selling securities to the public or having public reporting obligations. Those companies must provide the public with information about material effects of climate-change risks on its strategy, results of operations, financial condition, and governance structure. Many public companies must disclose certain greenhouse gas emissions.
In its statement supporting the new rules, the SEC responded to comments about its legal authority and used many pages to explain its interpretation of the statutes empowering the SEC to write binding disclosure rules. The SEC’s explanation of its legal authority does not hold up well and should not be accepted by the courts.
In a series of blog posts, I will analyze the SEC’s legal justification for the climate-change disclosure rules, using some points I made in earlier submissions to the SEC.
This first post summarizes the SEC’s position on its statutory authority and explains the statutory analysis the SEC should have done. The SEC’s position failed to follow the method of statutory interpretation prescribed by the Supreme Court and instead relied on isolated statutory language taken out of context. The SEC neglected to address the full text and context of the statutes, which grant but restrict the SEC power to issue disclosure rules.
The second post returns to the SEC’s explanation and describes the ways the SEC’s approach to its authority departs from restrictions on the SEC in the text and context of the relevant securities statutes. The SEC relied on considerations not in the statutes and ignored the narrow form of the disclosure obligations Congress used.
The third blog reports an anecdote from the drafting history of the Securities Act that confirms the statutory context imposing restrictions on the discretion of the SEC to create new disclosure obligations. The anecdote involves President Franklin Roosevelt, Representative Sam Rayburn, and Harvard Law Professor Felix Frankfurter. The report of the House Commerce Committee on the bill that became the Securities Act contains language evidencing the episode, and a House report for the bill that became the Securities Exchange Act also has language restricting the discretion of the SEC to compel company disclosures. The relevant statutes have not changed in a way that matters since they were enacted in the early 1930s.
The fourth and final post shows the SEC ignored its own earlier decisions that the agency lacked the power to adopt special disclosure rules on environmental, climate change, and social policy issues. In the earlier decisions, the SEC said it needed a specific congressional mandate to have that power, which it did not have for the new climate-change disclosure rules. These decisions confirm that the SEC lacked authority for the new rules.
The series of blogs will refer to the SEC’s statement supporting the final rules as the “Release.”[1] The new “Rules” are at the end of the Release. References to page numbers of the Release will usually be inside parentheses in the text.
The SEC’s claim of authority
The SEC began its analysis of statutory authority for the Rules by referring to provisions on mandatory disclosures from issuing and reporting companies, section 7(a)(1) of the Securities Act and sections 12(b) and (g) and 13(a) of the Exchange Act. (21683) The SEC emphasized the parts of those provisions enabling it to issue disclosure rules as “necessary or appropriate in the public interest or for the protection of investors.” (21683)
The SEC said the “text” of the provisions demonstrated that Congress “authorized the Commission to update and build on that framework by requiring additional disclosures of information.” (21683) The provisions and “broader context” of the statutes authorized the SEC “to ensure that public company disclosures provide investors with information important to making informed investment and voting decisions. Such disclosure facilitates the securities laws’ core objectives of protecting investors, facilitating capital formation, and promoting market efficiency.”[2]
The SEC then looked to its historical practice and said it “amended its disclosure requirements dozens of times over the last 90 years based on the determination that the required information would be important to investment and voting decisions.” (21683-84) The Release marched through several disclosure rules the SEC adopted, such as the rules requiring disclosure of risk factors, material legal proceedings, and management discussion and analysis. Another major example was that “the Commission for the last fifty years has also required disclosure about various environmental matters.” (21685; see also 21670)
The SEC concluded that it had authority to promulgate the Rules because investors have expressed a need for more reliable information about the effects of climate-related events and indicated the information is important. (21685) It said “climate-related risks can affect a company’s business and its financial performance and position in a number of ways.” (21685)
The SEC’s conclusion about its legal authority covered some but not all of the two themes repeatedly used throughout the Release to justify the Rules. One theme was that investors desire climate-change information. It is important to them, and they expressed a need for it. (21669, 21685) The second was that a set of detailed, prescriptive disclosure obligations would improve the “consistency, comparability, and reliability of climate-related information for investors.” (21669, 21670, 21673, 21679)
Much about the SEC’s position on its statutory authority is not correct. The SEC interpreted the statutes to confer near total discretion on it to decide on disclosure duties as long as it could cross low thresholds on investor protection, efficiency, and capital formation. The emphasis was always on the grant of rulemaking power to the SEC while largely ignoring the limitations the statutes imposed. A good place to start the critique is with the Supreme Court’s method of interpreting an agency’s rulemaking power and application of that method to examine the statutes on disclosure rules in the Securities Act and the Securities Exchange Act.
Appropriate interpretation of the SEC’s disclosure rulemaking power
The Supreme Court’s normal and straightforward method of determining an agency’s rulemaking power is to examine relevant statutes in their context and with a view to their place in the overall statutory scheme:
In determining whether Congress has specifically addressed the question at issue, a reviewing court should not confine itself to examining a particular statutory provision in isolation. The meaning—or ambiguity—of certain words or phrases may only become evident when placed in context. It 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. A court must therefore interpret the statute as a symmetrical and coherent regulatory scheme and fit, if possible, all parts into an harmonious whole . . . .[3]
The statutory context of the Securities Act and the Securities Exchange Act limits the SEC’s power to issue disclosure rules to specific types of information about the disclosing company’s business, finances, and securities that bear on investment returns. Congress consistently restricted the information an issuer or reporting company should disclose to certain internal characteristics of the company, such as financial statements, core business information, directors and management, and a description of the securities being sold.
Section 7(a)(1) of the Securities Act says that a registration statement for a public offer “shall contain the information” and documents “specified in Schedule A” of the Act.[4] Schedule A has 31 items including the business of the company, its capital structure, use of proceeds from the sale of securities, director and officer compensation, material contracts, and detailed balance sheet and profit or loss statements.
Congress added two qualifications to the disclosures required by Schedule A. First, the SEC may, by rule, exclude some of the information if it concludes that the information is not necessary for adequate disclosure to investors in particular classes of issuers. Second, the SEC also may adopt rules to require a registration statement to include other information or documents as “necessary or appropriate in the public interest or for the protection of investors.”[5]
The SEC read these words to say that Congress “authorized” the SEC to require disclosure of information in Schedule A. (21683) The SEC viewed Schedule A as optional suggestions, leaving the SEC free to create its own set of disclosure obligations.
That was not a fair reading of the statute as a whole. The better reading is that Schedule A is the base disclosure for a registration statement. The detailed list of data in Schedule A is the “heart” of the Securities Act.[6] The statute says a registration statement “shall contain” the Schedule A information, not that the SEC is “authorized” to require it. It gives the SEC limited discretion to add to or subtract from the Schedule A items when it has a good reason, but the agency is not free to treat a power to create exceptions as the power to develop a new system. Legislative history to be discussed in a later blog post made this same point.
The SEC and supporters relied heavily on the sentence giving the SEC the ability to require additional disclosure, but they take it entirely out of context. The sentence takes on a different and much more circumscribed meaning when read together with the mandatory use of Schedule A and the SEC’s power to issue rules relieving a class of issuers of a Schedule A requirement.
Similarly, the discussion in the Release of the rulemaking power under sections 12 and 13 of the Exchange Act stressed the SEC’s discretion while ignoring the limitations in the statutes. Section 12 gives the SEC power to adopt rules governing the information certain companies must disclose, but this SEC rulemaking power is expressly limited to specific categories of information and documents. The categories include the nature of the business, the terms of outstanding securities, descriptions of directors, officers, and major shareholders, material contracts, balance sheets, profit and loss statements, and other financial statements.[7]
Section 13(a) provides for periodic reporting obligations of some companies in accordance with rules the SEC “may prescribe as necessary or appropriate for the proper protection of investors and to insure fair dealing in the security.”[8] That rulemaking authority for periodic reports must be read with section 13(b)(1), which restricts the power to certain subjects.[9] The subjects are accounting items, such as the details for a balance sheet and the methods to be followed in the valuation of assets and liabilities. The statutes explicitly restrict the SEC’s ability to issue disclosure rules for reporting companies.
Other statutes in the Securities Act provide further context for the extent of the SEC’s power to issue rules on disclosure. In these statutes, Congress set the terms for types of offerings other than public offerings and for certain resale transactions and specified the disclosure topics along with a grant of some amount of rulemaking power to the SEC. Time and again, when Congress provided for a company’s disclosure obligations, it consistently singled out essential information about the company’s business, securities, management, financial statements, and securities offering process.[10]
The new climate-change disclosure rules do not respect the limitations in the securities acts and do not follow the form or method of disclosure obligation that Congress used. The main disclosure in the new Rules requires a description of “any climate-related risks that have materially impacted or are reasonably likely to have a material impact on the” company. On its face, that regulation does not fit within the powers conferred by the statutes discussed above, which have remained since enactment. The next post in this series will discuss the ways in which the new Rules fail to comply with the applicable securities statutes.
[1] SEC, The Enhancement and Standardization of Climate-Related Disclosures for Investors, 89 Fed. Reg. 21668 (Mar. 28, 2024).
[2] Release 21683 (footnote omitted); see also id. 21671. The SEC mentioned “voting decisions” but did not cite the section of the Exchange Act on its power over proxy solicitations, 15 U.S.C. § 78n(a), in the list of authorities for the Rules. See Release 21912.
[3] FDA v. Brown & Williamson Tobacco Corp., 529 U.S. 120, 132–33 (2000) (citations and quotation marks omitted); see also West Virginia v. EPA, 142 S. Ct. 2587, 2607-08 (2022); National Fed’n of Indep. Bus. v. Dep’t of Labor, 142 S. Ct. 661 (2022); AMG Capital Management, LLC v. FTC, 141 S. Ct. 1341, 1348-49 (2021); Util. Air Regul. Grp. v. EPA, 573 U.S. 302, 318–20, 321 (2014); Texas v. United States, 809 F.3d 134, 179–84 (5th Cir. 2015).
[4] 15 U.S.C. § 77g(a)(1). A different schedule applies to securities sold by foreign governments.
[5] 15 U.S.C. § 77g(a)(1).
[6] Joel Seligman, The Transformation of Wall Street 70 (3d ed. 2003); see also James M. Landis, The Legislative History of the Securities Act of 1933, 28 Geo. Wash. L. Rev. 29, 38 (1959) (the core of the registration requirements lay in the schedules).
[7] 15 U.S.C. § 78l(b)(1).
[8] Id. § 78m(a)(1)–(2).
[9] Id. § 78m(b)(1).
[10] See 15 U.S.C. § 77c(b)(2)(G)(i) (requiring a company selling a small issue to disclose audited financial statements, a description of the business operations, its financial condition, corporate governance principles, and use of investor funds); id. § 77c(b)(4) (requiring a company selling a small issue to make continuing periodic disclosures about its business operations, financial condition, corporate governance principles, and use of investor funds); id. § 77d(d)(3) (requiring, in a resale transaction from a buyer of securities to an accredited investor, disclosure of information about the issuing company, its business, securities, officers and directors, information about payments to sell the securities, and various financial statements); id. § 77d-1(b)(1) (requiring, in a crowdfunding transaction, disclosures of information about the issuing company, its business, securities being sold and capital structure, officers, directors, and major shareholders, and use of proceeds).
Andrew N. Vollmer is a senior affiliated scholar with the Mercatus Center at George Mason University; former deputy general counsel of the Securities and Exchange Commission; former professor of law, general faculty, at the University of Virginia School of Law; former partner in the securities enforcement group of Wilmer Cutler Pickering Hale and Dorr LLP.