Better information leads to better decisions — this is the idea behind a regulatory device known as “mandated disclosure.” Mandated disclosures are all around you, from calorie counts on fast food restaurant menus to conversations with doctors around informed consent.
But the biggest experiment yet in mandated disclosure may be an expected U.S. Securities and Exchange Commission proposal to extend these ideas to climate impacts facing U.S.-listed companies. Climate disclosure rules would require publicly traded companies to release information to investors about their emissions and how they are managing risks related to climate change and future climate regulations.
While it is easy to spot climate change-related risks facing companies like ExxonMobil that produces and sells fossil fuels that contribute to global warming, hidden vulnerabilities exist for businesses across the U.S. economy.
Largely in response to investors clamoring for more information about climate risks, as well as pressure from green groups that believe disclosure will drive climate-conscious investing, SEC Chair Gary Gensler announced in 2021 that the commission would use its statutory authority to require climate-related disclosures.
As law scholars, we work on legal issues involving businesses and regulation. Here’s what you need to know about climate disclosures and some of the challenges the SEC faces in adopting them.
What Investors Want to Know
Investor pressure for better information about climate impacts comes from two directions.
First, some investors want to avoid companies that will be affected by climate change. The company’s products may be regulated in the future because of their impact on the climate, or its supply chains may get more expensive over time. Investors want to know which businesses will be able to adapt and preserve profitability.
Second, many investors are interested in ESG investing, which involves assessing companies’ commitments to environmental, social and governance factors. Today, ESG investing accounts for US$17.1 trillion — or 1 in 3 dollars — of the total U.S. assets under professional management. The challenge for the SEC is to ensure that claims being made about the sustainability of a company are based on reality.
The trend toward ESG investment has led to an outpouring of voluntary disclosure: About 90% of companies in the S&P 500 publish voluntary reports disclosing statistics on things like carbon emissions and how much renewable energy they use.
Some large investors require disclosure. For example, BlackRock, a multinational asset manager with around $10 trillion under its control, requires companies it invests in to disclose certain climate information. The United Kingdom plans to require climate disclosure starting in April 2022, and the European Union has reporting rules in place.
But the U.S. has been slow to impose mandatory climate disclosure requirements. Public companies have only been subject to a more general legal standard that they not materially mislead investors. The SEC released guidance in 2010 to encourage climate disclosures, but it was unenforced and failed to prompt standardized disclosures.
Rule Benders and the Effectiveness of Disclosure
One reason is that the companies can easily evade disclosing useful information while still complying with the letter of the law. These “rule benders” can be very creative. Consider the restaurant in New York City that was subject to a health inspection grading regulation and managed to disguise its “B” rating by simply adding “EST” to its display of its grade. Disclosure regulations can also fail when they don’t effectively communicate valuable information.
A study of one type of climate disclosure – emissions labels on consumer products – found mixed evidence as to whether consumers altered their behavior in response. Rule benders can exploit human tendencies to discount or filter out warnings by providing an avalanche of unnecessary information that confuses and overwhelms the intended recipient.
Expect Court Challenges
One challenge the SEC has grappled with is whether it has statutory authority to require companies to disclose their “Scope 3” emissions. These are emissions that a company doesn’t directly control, such as emissions from the use of its products or emissions in its supply chain.
A company like Amazon may have extensive upstream Scope 3 emissions in its suppliers’ transportation networks. General Motors would have extensive downstream emissions when people drive its gas-powered vehicles.
The SEC’s three Democratic commissioners, who make up a majority of the commission, have reportedly split on whether certain Scope 3 emissions can be viewed as “material” to investors and therefore subject to disclosure.
“Material” is defined as information that a reasonable person would consider important in making an investment decision.
Some critics of climate disclosures, including several Republican state attorneys general, suggest that the SEC has no authority to require disclosures that are not financially material. Missouri’s attorney general wrote that requiring climate reporting would impose “large costs and administrative burdens” on publicly traded companies. A group of senators suggested greenhouse gas-related assets would shift to private companies. West Virginia’s attorney general threatened to sue the SEC.
The costs of disclosure would vary. Some companies already intensely monitor emissions. Others would likely face high costs if Scope 3 emissions were included. An oil company, for example, might have to measure emissions from all the vehicles using its fuel.
The Administrative Procedure Act allows courts to vacate SEC rules that are deemed arbitrary or capricious because the agency failed to offer sufficient justification for choosing the proposal over alternatives. The SEC is acutely aware of this risk. A prior oil and gas extraction disclosure rule was invalidated by a court in 2013 as arbitrary and capricious.
Proceeding With Caution
The SEC’s forthcoming climate risk disclosure rule will not be the final effort to use information to shape the private sector’s response to climate change.
What the SEC does now will affect those future moves. No wonder it is taking its time and proceeding cautiously.