Part of the bargain of being a public company in the United States is that the firm must submit to the authority of the Securities and Exchange Commission (SEC) and its ability to require mandatory disclosures. However, that authority is not unlimited: the SEC cannot go beyond what the law will allow.
This limitation has significance even when you accept the argument that the SEC has the authority to require disclosures regardless of whether they are material to a reasonable investor. This is an argument that is likely to be adopted by the SEC when it soon proposes its highly anticipated mandatory climate-change disclosures.
If the SEC is not limited by a materiality standard, then what are the statutory parameters or boundaries that it still must abide by? In my recent comment letter to the SEC, I argue that any new mandatory climate-change disclosures must be limited to informing investors of the firm-specific risks involved when making an investment in securities.
“In the Public Interest”
For the SEC to mandate disclosures, it must do so “in the public interest.” Even though the term is mentioned numerous times in both the Securities Act of 1933 and the Securities Exchange Act of 1934, the Acts do not attempt to define it. Therefore, under any fact pattern, it is up to the SEC to take the first crack at defining the term, and that definition will be given deference by a federal court. However, that deference is still reviewable, and the SEC’s definition can be rejected by a court if it has a “substantial reason for doing so.” That is, deference may be rejected under the Administrative Procedures Act (“APA”) if its actions were found to be “arbitrary, capricious, an abuse of discretion, or otherwise not in accordance with law.”
But how do we know when the SEC has it wrong in its definition of “in the public interest” when promulgating mandatory disclosures, including those involving climate change? As argued below, mandatory disclosures are not “in the public interest” when they go beyond the statutory requirement of being “for the protection of investors.”
“For the Protection of Investors”
Whenever the term “in the public interest” appears in the Acts, the term “for the protection of investors” is almost always sure to follow. This indicates a strong intertwining of the two terms. Moreover,according to a 1996 speech by former SEC chairman Arthur Levitt, “the foremost mission of the SEC for 62 years has been investor protection, and no matter how well-intentioned any additional role may be, it will inevitably distract attention from our primary focus. That’s a price we can ill afford.” As a result, the SEC would be committing an arbitrary and capricious act, an act in violation of the APA, to promulgate mandatory disclosures based on the rationale of being “in the public interest” but not “for the protection of investors.” One must go with the other.
What does “for the protection of investors” mean? The term is also not defined in the Acts. However, the meaning should be clear. The Acts, as a response to the stock-market crash of 1929 and the events preceding, focus on protecting “investors from fraud, an unlevel informational playing field, the extraction of private benefits from the firm by firm insiders, and investors’ propensity to make unwise investment decisions.” Such protections ensure that investors are adequately informed of firm-specific investment risks.
Such disclosures can include those that result from climate change.The SEC’s 2010 interpretative release on climate-change disclosures recommends the disclosure of a number of climate-change risk factors that “make an investment in the registrant speculative or risky” or “are reasonably likely to have a material effect on a public company’s financial condition or operating performance”—for example, the impact on the company of climate-change legislation and regulation; international accords on climate change, such as the Paris Accord; indirect consequences of climate-change regulation, such as a reduction of demand for goods that create high levels of greenhouse gas emissions; and the physical impacts of climate change, such as severe weather, on the company’s operations.
No doubt it is time to update the SEC’s 2010 interpretative release. However, while the Acts provide the SEC with authority to require disclosures regarding firm-specific investment risks, they do not specify or imply that mandatory disclosures should be used for the purpose of allowing investors to protect themselves from investing in securities that they simply find objectionable. Professor Michael Guttentag refers to this as “expressive investor protection”—for example, disclosures on the level of Scope 1, 2, or 3 carbon emissions that a public company may produce. Such disclosures would allow investors to avoid investment in the securities of a company that produces carbon emissions that go beyond a certain level. While these disclosures are something that investors may desire, they are simply not “for the protection of investors,” and therefore requiring such climate-change disclosures would be an arbitrary and capricious act under the APA. For the SEC to have such authority, Congress must provide it in new legislation.
