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US Supreme Court ruling may check SEC plans to seek climate risk disclosures

06 July 2022 Amena Saiyid

A recent US Supreme Court ruling not only checked the Environmental Protection Agency's authority to limit coal-fired power plant GHG emissions through switching fuels. The 6-3 decision also provided a warning for other federal agencies seeking to broaden their climate credentials beyond congressional mandates, lawyers say.

The US Securities and Exchange Commission (SEC) is one such agency that could come into the crosshairs of the Supreme Court with its forthcoming rule requiring publicly traded companies to disclose climate-related financial risk.

Responding to burgeoning investor demand, the SEC released the climate disclosure proposal on 21 March, which for the first time would require publicly traded companies to disclose their strategy, governance, and risk management with respect to climate-related financial risks.

The proposed rule on which the SEC accepted comments until 20 June would require companies to disclose Scope 1 GHG emissions from their direct operations as well as Scope 2 emissions from purchasing electricity for heating and cooling purposes. The agency stopped short of mandating Scope 3 emissions disclosures unless investors deem it "material" or companies themselves have listed Scope 3 reduction targets in their transition plans.

The SEC rule would be subject to the major questions doctrine, which six of the nine justices on the Supreme Court invoked in their West Virginia v. EPA opinion to limit EPA's regulatory authority over power plant GHG emissions.

The major questions doctrine is a Supreme Court interpretation of the US Constitution in a 1999 ruling over sales tobacco products. In FDA vs. Brown & Williamson Tobacco Corp., the court held that a federal agency, such as the Food and Drug Administration, could not make sweeping regulatory changes unless Congress explicitly authorized such an action. The Supreme Court has used this doctrine most recently in January 2022 to roll back Biden administration attempts to require mandatory COVID-19 vaccines across the nation for workplaces with at least 100 employees.

'Staple' of administrative litigation

This doctrine will cast a shadow over the federal regulatory process, and perhaps create hurdles any forward movement on President Joe Biden's climate agenda, according to at least one energy analyst and lawyers.

"The ruling creates headwinds for investor's appetite for utility-scale renewable energy that would otherwise replace fossil fuel generation in the US," said Peter Gardett, executive director for S&P Global's Financial and Capital Markets.

He said the court's ruling presents "an unaccustomed challenge" for financial and capital market participants evaluating their climate risk or deploying investments into cleantech markets in the US.

In an area where financial markets are just getting their arms around technology and operational risks, there is now a meaningfully increased degree of political and litigation risk added to deals completed, underway or proposed," Gardett said.

Leah Dundon, a Beveridge & Diamond attorney, is of the opinion that the West Virginia ruling will make SEC rulemaking more challenging, but will not make a difference to investors who have been seeking increased information about climate-related financial risks and opportunities even in the absence of a comprehensive plan.

"There are already pressures outside of what EPA or the SEC is doing - such as what other countries are doing or what investors or market forces are demanding - and that is not likely to change based on the West Virginia case," Dundon told Net-Zero Business Daily.

Fresh from the Supreme Court victory, West Virginia Attorney General Patrick Morrisey has made no bones about using this doctrine to challenge federal regulatory authority that he said is overreaching its bounds. Morrisey is using the same argument in challenging EPA fuel economy standards for model years 2023-2026.

Eric Christensen, a principal with the Beveridge & Diamond law firm told Net-Zero Business Daily the major questions doctrine could become "a regular staple of administrative litigation involving just about every federal agency."

This does not bode well for the SEC or for any federal agency, according to multiple lawyers.

"This decision sets the screen through which regulations are going to have to pass," said Chris Carr, who heads the environment and energy practice at the Paul Hastings law firm in San Francisco.

Broader challenges expected to SEC rule

Sarah Fortt, an attorney with Latham & Watkins who also is global co-chair of the firm's ESG practice, noted that the scope of the SEC's congressional mandate has generally been interpreted broadly for rules requiring corporate disclosures.

In one respect, she said the Supreme Court's 6-3 decision in West Virginia v. EPA is drawn more narrowly than the legal challenges expected in response to final SEC climate-related rules.

"However, in another very important respect, the decision could be interpreted as directly addressing the scope of the SEC's authority to promulgate climate-related disclosure rules in as so far as such rules could have significant economic impacts on companies and address a political matter that has been the focus of congressional debate," Fortt wrote in a 5 July email to Net-Zero Business Daily.

In Dundon's view, the difference between the EPA regulation, which the Supreme Court tackled in West Virginia, and the SEC proposal is that the former was attempting to change the nation's energy mix, while the latter is more of an information gathering exercise.

She said the SEC has been very careful about linking the new climate reporting regime it is seeking to craft directly to its authority either in the 1933 Securities Act or the 1934 Exchange Act to protect investors based on financial risks.

Nonethless, Dundon said, "there is no doubt that the SEC proposed rule represents a major new regulatory scheme and it is very possible this Supreme Court may feel it has gone to far afield of the Congressional authorizing language in the statute that SEC relies on (either based on the plain language of the statute or the "major question" doctrine)."

What is "pretty dramatic" about the proposed regulation is that the SEC treats companies differently if they have "already voluntarily" been reporting Scope 3 or undertaking scenarios analysis from those that have not, Dundon said.

She said the court could reject the SEC rule also on grounds that Congress has had various climate risk disclosure bills put forward, "but none have been enacted."

Scope 3's impact on markets

The Scope 3 reporting aspect of the proposal is where Fortt sees the SEC running into trouble under the major questions doctrine.

"Given the nature of the rules, there could also be an argument that their total impact on the markets and the economy could be significant enough that the rules, or at a minimum, certain aspects of the rules (Scope 3 emissions disclosure possibly being one such aspect) should not be undertaken absent a clear congressional mandate and the rules should therefore be assessed under the major questions doctrine," Fortt added.

She pointed to Justice Neil Gorsuch's concurring opinion that articulates an approach to the major questions doctrine that could be used to argue more broadly that the SEC's rulemaking on climate-related matters falls outside of the scope of its existing congressional mandates.

"We expect that his opinion together with the majority opinion are likely to be used to make several layered arguments in the litigation likely to occur following the SEC's adoption of final rules," Fortt said.

In that concurrence, Gorsuch, who was joined by Justice Samuel Alito, pointed to attempts by federal agencies like the Occupational Safety and Health Administration or the Centers for Disease Control and Prevention to invoke what Beveridge & Diamond attorneys noted are "long-extant legal authorities to address new challenges like COVID."

According to a 30 June note by Beveridge & Diamond, the high court's decision gives litigants like West Virginia "a powerful new tool" to challenge regulations where the agency claims authority based on older statutes or statutes in which the grant of authority is not explicit.

This includes not just EPA attempting to address modern environmental challenges such as climate change by using older statutes like the Clean Air Act, but any agency in a similar situation, such as the SEC.

Don't short-circuit Congress

Following the court's decision on 30 June, Morrisey told reporters he was grateful to the Supreme Court for recognizing and checking the Biden administration's attempts to "use the agency process to short-circuit Congress' role under the US Constitution."

At the press conference, Morrisey warned Biden that the state would "very carefully" examine federal regulatory actions to address climate, particularly the SEC's climate risk disclosure rule, in light of the court's reading of the major questions doctrine.

"I think [the SEC climate risk disclosure rule] would also fall into the major questions category where the Biden administration is trying to transform all these agencies from their traditional mission and turn them all into environmental regulators," he added.

"Mr. President, that is not what was intended under the Constitution, and we are going to be standing by to make sure that doesn't happen," Morrisey said.

He said West Virginia has already sent a 24-state comment letter on the SEC's proposal. The letter questioned SEC's authority to require climate change disclosures "without a showing that they are needed to prevent misleading or fraudulent representations."

SEC rule on sound footing?

This is despite assertions made by SEC Chairman Gary Gensler that the agency's actions are backed by Supreme Court precedent.

In early April, Gensler said two US Supreme Court opinions and the agency's long-standing tradition of providing "material" information to investors back its climate risk disclosure rule.

As the Supreme Court held in the 1988 Basic Inc. v. Levinson ruling that in turn cited a 1977 opinion, Gensler said "information is material if 'there is a substantial likelihood that a reasonable shareholder would consider it important' in making an investment or voting decision, or if it would have 'significantly altered the total mix of information made available.'"

Arguing over materiality

The SEC is expected to issue its final rule in October, where it will have to defend its action against West Virginia's arguments that "materiality" is limited to information that protects investors against fraudulent activity.

Dundon agrees with Gensler that the definition of materiality has been reaffirmed by the supreme Court. However, she added, "if five members of the court think precedent was wrongly decided they will not hesitate to overturn it." The Supreme Court ruled 5-4 to overturn federal abortion rights granted in Roe v. Wade when it decided Dobbs v. Jackson Women's Health Organization on 24 June.

In Dundon's view, "the definition of materiality is at play in what is material depends on what is important to a "'reasonable" investor.'"

She expects to see new litigation arguing that the "reasonable" investor is now concerned about climate-related metrics and risks generally.

More importantly though, Dundon said, "the question will be whether what the SEC is doing substantively - imposing sweeping line-item climate reporting rules - goes beyond their authority, and separately whether the standard of a 'reasonable investor' - which is central to the definition of materiality, has changed."

Posted 06 July 2022 by Amena Saiyid, Senior Climate and Energy Research Analyst

This article was published by S&P Global Commodity Insights and not by S&P Global Ratings, which is a separately managed division of S&P Global.


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