SEC bogs down on climate rule, handing White House fresh setback

At issue is how much environmental data companies can be forced to disclose before regulators put themselves in legal jeopardy.

The Biden administration faces a fresh environmental setback after its signature climate initiative flopped in Congress, this time as a Democratic rift on the SEC stalls efforts to bring corporations into the fight against global warming.

At issue is a planned Securities and Exchange Commission rule that could force public companies to disclose details such as the amount of energy they buy and how they manage risks posed by rising temperatures. The regulation is a top goal for the White House, and SEC Chair Gary Gensler had pledged to unveil a proposal by the end of last year. Now, the timeline has likely slipped to March or even later, people familiar with the matter said.

The conflict, which pits Gensler against his two fellow Democrats on the commission, is largely over how much information the agency can force companies to divulge without losing an almost certain legal challenge brought by Washington’s business lobby or a Republican-led state. Another flashpoint involves whether auditors should sign off on the disclosures, ensuring they would be vetted by the same independent watchdogs who review corporations’ financial statements.

Adding pressure is last year’s collapse in the Senate of another centerpiece of President Joe Biden’s climate agenda, some $550 billion in tax credits and spending for clean energy. Democratic activists are counting on the SEC to fill that void and give the president a significant policy victory heading into November’s midterm elections. A proposal can only move forward by majority vote, and with the SEC’s lone Republican opposed, all three Democrats need to support it.

But the SEC faces a dilemma. If its rule lacks teeth, progressives will be outraged. On the flip side, an aggressive stance makes it more likely the regulation will be shot down by the courts, leaving the Biden administration with nothing. Either way, someone is going to be disappointed.

Politicized issue

“Climate is an issue that for a lot of people is politicized,” said Matt Orsagh, senior director of capital markets policy at the CFA Institute who focuses on environmental, social and governance issues. “You are going to have some people who are thrilled and some people who think it’s terrible.”

The internal debate over how tough the rule should be is rare among the SEC’s Democrats, who are aligned on most policies, including pushing for a clampdown on cryptocurrencies, boosting oversight of Wall Street and levying steep fines on corporations accused of wrongdoing.

Underlying the climate dispute is a legal quandary over “materiality”— a term that dictates what companies must disclose to shareholders. The definition for the concept is vague under securities laws, and federal judges have never established a clear guideline. The SEC has been no better, saying material information is that “which there is a substantial likelihood that a reasonable investor would attach importance.”

Gensler, 64, has been cautioning agency staff to make sure the climate proposal adheres to a legally defensible definition of materiality. He contends that only this approach can survive a legal challenge.

The SEC chief isn’t alone in believing a lawsuit is inevitable. Most Republicans insist that regulating global warming is outside the agency’s jurisdiction, and business groups have already been discussing a litigation strategy. The attorney general for West Virginia, the heart of U.S. coal country, sent the SEC a clear warning last March vowing to defeat the agency in court if it pursues “a president’s political agenda.”

Blazing new path

The SEC’s other Democrats, Commissioners Allison Herren Lee and Caroline Crenshaw, are less worried about a lawsuit, the people said. Instead, they say the dangers posed by climate change are too serious to take small steps, especially because the disclosures will blaze a new path in securities oversight. Any rule, they maintain, should be broad and not tied to a narrow definition of materiality.

Representatives for Gensler, Lee and Crenshaw all declined to comment, as did the White House.

Tensions over the divergent approaches have reached a tipping point, said the people, who asked not to be identified discussing private negotiations. At one meeting, they said, Gensler told SEC lawyers that their work must conform with the interpretation of materiality that has been laid out by the U.S. Supreme Court — a standard that underpins the SEC’s guidance. Gensler made clear that, as far as he was concerned, there would be no more debate on the issue, the people added.

If Gensler’s edict stands, securities lawyers say, companies probably wouldn’t have to report on many aspects of so-called Scope 3 emissions — a broad term that essentially refers to pollution from other businesses in their supply chains and users of their products.

That would be a win for corporations that have long argued that such data aren’t part of their core operations, and thus not material to their businesses. Requiring details about areas they don’t control, opponents say, also unfairly makes companies vulnerable to shareholder lawsuits and government enforcement actions.

Companies concerned

“It’s incumbent upon the SEC to think about how difficult it is for companies to get this information,” said Keith Higgins, who previously led the regulator’s division that writes rules for corporate disclosures. “It’s a real challenge, and companies are rightfully concerned.”

Environmentalists, however, would be equally peeved if Scope 3 is left out because they say that such emissions account for the bulk of a company’s pollution.

And Lee and Crenshaw argue that investors, not companies, get to determine what’s material. To bolster their position, they point to the groundswell of large investment firms calling for more disclosure about how the warming planet is impacting markets. That includes the largest asset management firms, like BlackRock Inc. and State Street Corp., which oversee trillions of dollars of people’s savings.

“Investors, the arbiters of materiality, have been overwhelmingly clear in their views that climate risk and other ESG matters are material to their investment,” Lee said in a speech last year.

SEC officials also are debating whether auditors should approve companies’ climate reports. Lee and Crenshaw argue that step is necessary to assure investors that the disclosures are accurate.

Strong rule

Gensler, however, is concerned that forcing audits as opposed to other types of assessments won’t pass muster with a legal requirement that the SEC show the benefits of its rules outweigh the costs, a mandate that opponents often sue over. The chair also has noted that there are no official standards for auditors to follow. Writing those would likely take more than a year and give foes another forum to fight the requirements.

There’s urgency to move forward because of the SEC’s drawn-out rule-making process. A first vote by commissioners simply ensures that a proposal is submitted for public feedback. They then must reconvene months later to formally approve it, and companies are usually granted a lengthy phase-in period before they have to comply.

Ultimately, the agency should focus on passing a strong rule and worry less about getting sued, said former Democratic SEC Commissioner Robert Jackson Jr.

“Striking this kind of balance is the most difficult work the commission does, particularly for a historic rule-making like this,” he said. “Their policy choices should be driven by their conviction about how best to protect investors, not lobbyists’ self-interested speculation about what randomly chosen federal judges might say when industry inevitably sues.”