SEC climate disclosure rule faces legal gantlet

By Lesley Clark | 03/11/2024 06:08 AM EDT

The Securities and Exchange Commission’s compromise on the landmark rule seemed to make everybody mad.

Securities and Exchange Commission headquarters

The Securities and Exchange Commission headquarters. Andrew Harnik/AP

A top Wall Street regulator’s decision to force public companies to divulge details about their climate risk could draw the attention of a Supreme Court that has displayed interest in curbing government efforts to tackle climate change.

The landmark Securities and Exchange Commission rule — approved last week by a 3-2 vote — drew immediate legal challenges from Republican-led states and energy companies.

The challenges came despite the SEC’s move to dramatically roll back its original proposal, a revision that included dropping a requirement that some companies report emissions associated with their customers and sprawling supply chains.


“The SEC tried hard to mollify corporate America on how expensive this would be, but there are enough companies and enough states who hate the idea of a capital markets regulator taking on a climate role,” said David Zaring, a professor at the University of Pennsylvania’s Wharton School of Business.

It’s not just corporations that are mad. The SEC’s step back has also prompted environmentalists to threaten to sue the agency over what they called an “arbitrary removal” of key measures from the rule.

“The definition of a compromise is that each side is equally unhappy,” said Steve O’Day, partner and head of the environmental law, energy and sustainability practices at the firm Smith, Gambrell & Russell. “And the fact that both sides are unhappy increases the likelihood of litigation.”

The SEC’s legal challengers have yet to detail their issues with the nearly 900-page rule, but the industry is widely expected to invoke the “major questions” doctrine, a legal theory championed by conservatives that says Congress must clearly provide permission for an agency action of political and economic significance.

The Supreme Court cited the doctrine by name for the first time in West Virginia v. EPA, a landmark 2022 ruling that curbed EPA’s ability to regulate greenhouse gas emissions from coal-fired power plants. The decision didn’t specify how or when a regulation may qualify as “major,” but conservative groups have embraced the doctrine to go after the Biden administration’s most ambitious climate initiatives.

“The argument will be that the SEC has gone outside of its delegated mission by seeking to do something about climate change,” O’Day said.

O’Day said that the SEC was created after the 1929 stock market collapse to protect investors. “Part of protecting investors is providing them with information,” he said, “so they’ve got a good argument to defend the rule.”

But the SEC may have a difficult time making that argument in court, Zaring said. Although the SEC says it has required environmental disclosures in the past, he said, the rule marks the first time it has tried to require companies to report on their environmental impact.

“The SEC’s not an environmental regulator,” Zaring said. “It’s charged with investor protection.”

West Virginia Attorney General Patrick Morrisey, who announced a multistate lawsuit against the rule just hours after the SEC vote, said the major questions doctrine that he successfully invoked in West Virginia v. EPA will be relevant to the SEC challenge.

The rule, said Morrisey, a Republican, is “not tethered to clear statutory authority.”

Morrisey characterized the SEC rule as an attack on the energy industry. Two fracking companies — Liberty Energy and Nomad Proppant Services — have already filed their own lawsuit against the regulation.

Where will the lawsuits land?

It’s unclear which court will hear lawsuits over the SEC’s new rule.

Liberty Energy and Nomad Proppant Services filed in the 5th U.S. Circuit Court of Appeals, which is viewed as one of the nation’s most politically conservative courts. Louisiana, Texas and Mississippi filed a lawsuit there as well. Morrisey and nine other state attorneys went to the conservative-leaning 11th U.S. Circuit Court of Appeals.

The venue for the cases will be randomly chosen between any federal appeals court where a petition is filed over the coming days.

Zaring, who called the proposal “doomed” on X, formerly known as Twitter, said it’s possible the SEC rule will get struck down by a federal appeals court before making it to the Supreme Court.

The high court doesn’t have time to review every matter that comes its way, but the SEC’s rule is a “high-profile candidate” for review if the justices want to elaborate on the application of the major questions doctrine, he said.

States and companies may also invoke the Administrative Procedure Act, the law of federal rulemaking, which bars agencies from acting in an “arbitrary and capricious manner.” Under the APA, challengers could argue that the SEC failed to present a strong scientific basis for requiring corporate climate disclosure, Zaring said.

A challenge of the SEC’s cost-benefit analysis, which agencies conduct to justify their rules, is also “part of the playbook,” Zaring said. Nearly a quarter of the new climate rule — 214 pages — covers the cost-benefit analysis, he said.

“Because the SEC is pretty worried about defending rules on that basis,” he said, “it tries to do a very careful cost-benefit analysis when it does them.”

The U.S. Court of Appeals for the District of Columbia Circuit in particular has set a precedent for questioning the agency’s analyses, Zaring said. The court in 2011 struck down an SEC proxy access rule, finding that the agency’s cost-benefit analysis was defective.

Freedom of speech

SEC challengers also may look to raise First Amendment claims against the new climate disclosure rule.

In a 2014 lawsuit, the agency faced a freedom of speech challenge over a requirement that manufacturers report — and publish on their websites — whether their products contained “conflict minerals” mined in the Democratic Republic of the Congo or neighboring countries.

Congress had mandated the requirement, but the National Association of Manufacturers argued at the time that doing so violated companies’ First Amendment rights. The D.C. Circuit agreed, finding that the rule would have forced a business to “confess to blood on its hands,” Zaring said.

In lawsuits over the climate disclosure rule, he said, “I bet the attorneys general and probably everybody will say, ‘Look, you’re doing something similar. You’re sort of requiring a company to admit that it’s bad.’”

Still, Zaring said, the SEC “is in the business of compelling speech,” requiring various disclosures from companies. Last year, a panel of 5th Circuit judges rejected arguments from the U.S. Chamber of Commerce that another SEC disclosure rule violated free speech protections — though they did ultimately kill the rule.

“That’s a narrow line that courts are going to have to think about when they’re thinking about the First Amendment,” he said.

Morrisey of West Virginia raised the First Amendment in a press conference announcing the state’s lawsuit. He said the rule is creating a situation in which a federal agency is “forcing” a company to disclose information “it otherwise might not want to.”

Louisiana Attorney General Liz Murrill, who filed a separate challenge against the SEC, has said the new rule falls outside the agency’s authority and violates the First Amendment.

SEC Commissioner Caroline Crenshaw nodded to the criticisms Wednesday before the agency finalized the rule, saying that it has “clear authority” to require disclosures that are in the public interest and protect investors.

That “well-established authority,” Crenshaw said, “has been consistently relied upon, and affirmed and reaffirmed across dozens of disclosure rulemakings over multiple decades.”

Crenshaw, a Democrat who served as an SEC attorney before being appointed as a commissioner, said the agency’s disclosure regime for public companies is designed to be updated as markets innovate and as investors demand changes.

“We have heard the argument that this agency does not have authority to require disclosure of information related to greenhouse gases because such data are not financial metrics,” Crenshaw said.

But she said the SEC has previously updated disclosure requirements to include information about executive compensation, compliance with environmental protection laws, and the background and qualifications of directors.

Those nonfinancial metrics, she said, provide investors with information they can use to assess the overall state of a company.

“Likewise,” she said, “disclosure of GHG emissions provides information that helps investors understand the current and potential financial risks a company faces.”

More challenges on the way

The U.S. Chamber of Commerce, which is already suing California over similar corporate climate disclosure laws, has not ruled out a legal challenge to the SEC’s federal rule.

Tom Quaadman, executive vice president for the Chamber’s Center for Capital Markets Competitiveness, said the group would “continue to use all the tools at our disposal, including litigation if necessary, to prevent government overreach.”

Business groups argue that with the latest rule, the SEC is using its power to shame companies and force them to make operational decisions they otherwise wouldn’t consider.

But Mona Dajani, global co-chair of energy infrastructure and hydrogen at the law firm Baker Botts, said the opposition may be “short-term growing pains for a long-term benefit,” as the SEC rule brings the United States in line with disclosure practices in the European Union.

Yet even the SEC’s decision to “dramatically dial back” the most stringent reporting requirements is unlikely to stem legal opposition — particularly in an election year, Dajani said.

Republicans at the federal and state level have in the past two years redoubled their attacks against environmental, social and governance investing. Morrisey, who is running for governor in West Virginia, invoked his Supreme Court victory against the administration on power plant emissions rules in his first televised campaign ad released Friday.

“When Biden screws West Virginia, I sue Biden,” Morrisey says in the ad as headlines flash across the screen.

In addition to lawsuits from Republican-led states, Dajani said, “we’re seeing politics play a role with fierce opposition from Republicans in Congress who are expected to take some legislative action to overturn it.”

Dajani said the 24,000 comments the SEC received on its rule may have helped the agency bolster its legal case by providing its attorneys with a preview of the legal arguments that are likely to be used against it.

But, she added, “I don’t think there’s any way to bulletproof anything.”