Saving climate disclosure

It has been almost a year since the Securities and Exchange Commission (SEC) proposed that corporations should be required to disclose their carbon emissions, and the SEC is thought to be close to adopting a final rule. When it does, a judicial challenge is all but inevitable.

In a recent paper, Saving Climate Disclosure, I argue that the best way for the SEC to save climate disclosure and to protect investors is to let them decide. That is, the SEC should let companies opt out of all or part of their climate disclosure obligations if sufficient investors have voted to allow it to do so. This “investor-optional” approach would result in three important improvements necessary to save climate disclosure from invalidation, and best protect investors:

1. It would make the design of the SEC’s rule consistent with the SEC’s core claim that there is investor demand for climate disclosure; if this is indeed the case, a mandatory rule is not necessary, creating a logical inconsistency that threatens the validity of a mandatory rule.
2. Making climate disclosure investor-optional would circumvent claims that the rule is invalid, which—to the extent they apply at all—apply only to a mandatory disclosure rule.
3. An investor-optional rule would better protect investors than a mandatory rule, reducing their net costs, while preserving their benefits. As a result, the SEC is required to consider an investor-optional rule, and having done so, it will be difficult for the SEC to justify adopting a mandatory rule instead.

In this issue of the ECGI Blog, Virginia Harper Ho responds to my paper, arguing that the SEC should not let investors play a role in determining whether disclosure rules apply to companies. Professor Harper Ho and I disagree on several important points about my proposal. Below I respond by clarifying certain aspects of my proposal, and how it would help save climate disclosure and better protect investors.

Professor Harper Ho argues that “leaving it to investors” is the same, failed, approach that the SEC and the world’s major capital markets have been taking for years. But an investor-optional rule improves on the status quo in important ways. The status quo is effectively “opt-in” climate disclosure, with the opt-in decision made by directors and executives—who may have little incentive to do so. Investors have limited ability to influence the opt-in decision through engagement or shareholder proposals. And their collective action problems make it less likely that investors’ aggregate preferences will be heard. In contrast, because opting-out would require an investor vote, whether the company opted-out would be entirely up to a majority of investors.

Opt-out votes are unlikely to impose significant additional costs on investors. At many companies, there will be nothing to vote on. Where there is strong investor support for a company following all of the SEC’s disclosure requirements, rational directors will not expect investors to opt-out, and will not put the question to a vote. If investors do vote it will only be because many of them likely do not support certain disclosures. The investors whose votes would be decisive are large investors that already vote on many other proposals at hundreds or thousands of companies each year. They have voting policies and sophisticated mechanisms in place that allow them to make informed decisions on these matters at scale. Many already have policies on climate disclosure that they can follow.

Some opposition to investor-optionality seems to be predicated on the assumption that the most substantial parts of mandatory climate disclosure are likely to survive judicial scrutiny. I do not take a position on this question, and only note that many others appear to think there is a significant chance of a federal court invalidating the rule. Making the rule investor-optional would significantly reduce this risk. The strongest arguments against the rule apply—if they apply at all—only to a mandatory rule. Those arguing against an investor-optional rule should thus compare it not only to the mandatory disclosure they would prefer, but also to the prospect of mandatory climate disclosure being invalidated, leaving the status quo unchanged.

This is especially important because the benefits of investor-optionality strengthen the case for invalidating mandatory climate disclosure. As I explain in my article, clear precedent requires the SEC to consider reasonable alternatives to its proposed rule; these would obviously include an investor-optional rule. In order to nonetheless adopt a mandatory rule, the SEC would have to justify why it would be better for investors than an investor-optional rule. This will be very hard for them to do, for the reasons I detail in my article. Simply put, if a majority of investors favor all of the SEC’s disclosure requirements, then no companies will opt-out and an investor-optional rule will be no worse than a mandatory rule. But if a majority of investors in any company believe that some climate disclosure rules have greater costs than benefits to investors, then they will vote to opt-out, making the investor-optional rule less costly than the mandatory rule. If this is the case, forcing disclosure on such a company against its investors’ wishes could only be justified on the grounds their opt-out decision would hurt investors in other companies even more. This will be a hard case to make. Investors in the disclosing company are likely to share many of the same views about the benefits of disclosure as investors in other companies (including benefits from disclosure standardization). Indeed, the investors with the most votes—including BlackRock, Vanguard, and State Street Global Advisors—are also investors in many, many other companies. Their voting decisions will thus include the costs of opting-out for investors in other companies.

A case could be made that it is not investors in other companies that would benefit from mandatory disclosure, but others in society. Indeed, Professor Harper Ho also argues that climate disclosure’s mitigation of systemic risk is a potential justification for the SEC’s proposed rule. But if systemic risks are also risks to investors, they will weigh them in their opt-out decisions. And although there could be risks to non-investors, the SEC’s justification for its climate rule has been focused squarely on investor demand. The SEC has not even tried to make the case that climate disclosure is justified on the grounds of public interest beyond investors.

The centrality of broad investor demand to the SEC’s justification for climate disclosure reveals a paradox in the claims of those who are skeptical of investor-optionality. If a broad group of investors demand all of the disclosure required by the SEC’s rule, why would they opt-out? If they wouldn’t, then an opt-out rule is no worse than a mandatory rule. On the other hand, if a majority of investors believe the costs to investors of certain disclosure requirements exceed their benefits, then how can the SEC justify requiring such a rule in the interests of investors?

There is a simple way to resolve this paradox, and the competing claims regarding what investors want: Let investors decide.

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By Scott Hirst, Associate Professor, Boston University School of Law

If you would like to read Virgina Harper Ho's response to the Saving Climate Disclosure paper, click here

If you would like to read further articles in the 'Governance and Climate Change' series, click here

The ECGI does not, consistent with its constitutional purpose, have a view or opinion. If you wish to respond to this article, you can submit a blog article or 'letter to the editor' by clicking here.