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Last year, the SEC released very ambitious proposals for disclosures on climate-related issues with these soothing words: “Our core bargain from the 1930s is that investors get to decide which risks to take, as long as public companies provide full and fair disclosure and are truthful in those disclosures.” In the abstract, this message contains a good deal of sense. But in the concrete, the proposition contains some major ambiguities that need resolution to make good on this promise, especially in climate-related cases.
The first question: why would the government need to mandate disclosures of information when private parties, including sophisticated investors, can undertake their own investigations? The advantage of that voluntary system is that it does not require a public official to define exactly what must be done to secure “full and fair disclosure.” Parties who pose hard questions to issuers without getting satisfactory answers are free to go elsewhere. So the correct background assumption is that at best, the securities law should serve as a backup device to private inquiries, not as a first line of defense.
But it would be a mistake to assume that this backup never comes into play. Long before the passage of the Securities and Exchange Acts of 1933 and 1934, the common law had developed rules to deal with fraud, which necessarily had to address both concealment and nondisclosure. The danger of fraud is that it misstates the relative value of key items, especially when the seller makes it appear that his shares have extra value when they don’t. Two bad consequences follow. First, he swindles a buyer who pays $100 for an item worth only $75, and thus bilks his target of $25. Second, that individual imbalance also generates social costs by moving resources from higher- to lower-value uses. Yet the prohibition against fraud can easily be circumvented by stating some facts while omitting others. Whenever there is asymmetric access to information, the ability to conceal, or fail to disclose known facts, can have those same deleterious effects, which is why the SEC mantra of “full and fair disclosure” resonated long before the modern laws were passed.
Yet there is an enormous gulf between disclosures then and now, which renders the SEC’s climate pronouncement—The Enhancement and Standardization of Climate-Related Disclosures for Investors of March 20, 2022—so indefensible, given the sharp departure from earlier practice. To see why, look first how the issue arose before the SEC existed.
The major British case, Derry v. Peek (1889), involved a prospectus that made the false claim that a special act of Parliament gave the firm “the right to use steam or mechanical motive power, instead of horses,” to run their trams along public ways, when in fact that grant covered only part of the proposed system. The British court defined the scienter for fraud as “(1) knowingly, or (2) without belief in its truth, or (3) recklessly,” which had to be proved specially, although it is hard to think that the directors of the company could have been merely negligent, since they had to have their own agreements. The fraud standard was all too favorable to the issuers, and so, to short-circuit the misguided fraud inquiry, Parliament adopted Director’s Liability Act, 1890 53 & 54 Vict. ch. 64, which provided that a director or promoter of a corporation will be held liable for damages to purchasers of stocks and bonds unless the director or promoter can show that “he had reasonable ground to believe,” and at all material times did believe, his statements to be true. It is hardly too much to require this simple disclosure of a fact known to the issuer but not to his customer.
Years later, when the SEC adopted its basic view on disclosure in TSC Industries, Inc. v. Northway, Inc. (1976), it first held that the disclosures of an omitted fact had to be “material,” so that they counted only “if there is a substantial likelihood that a reasonable shareholder would consider it important in deciding how to vote” on a complex corporate (roll-up) transaction of which the sophisticated buyers, unlike the purchasers in Derry, had extensive prior information about company affairs.
Now apply these general background norms to the mandated disclosures called for in the climate case. The first point is that unlike in traditional disclosure cases, there are comprehensive systems of public environmental regulation well known to all potential buyers, who can make their independent assessment of their general worth. There are also reams of public information about the various efforts that have been made to control various forms of emissions from fossil fuels, notably coal, natural gas, and crude oil. One stark, prominently reported such fact is the decision by the Chinese government not to cut back on overall coal production to satisfy the demands of the United States. There is also ample public information about the level of emissions of carbon dioxide by nations over time, which again shows that China produces 2.58 times the amount of carbon dioxide generated by the United States. The United States has for the most part more efficient output than China for each unit of carbon dioxide production, given that its gross domestic product is around $23 trillion, compared to China’s $17.7 trillion. There are also powerful mandates from Biden administration executive orders requiring, among other steps, a rapid conversion to electric vehicles. These mandates paint a far rosier view of this process than do the many skeptics who think that the transformation will be far messier and costlier than the administration believes.
Ultimately here, as in other areas of life, the value of climate-related information is determined by its worth at the margin. Given the mass of regulations and the huge amount of public information, what is the value at the margin of the information about firm-level emissions?
The SEC starts by arguing that there is value in standardizing how the information is presented. But the SEC cannot hope to repeat the success of the “Schumer Box”—the compact, standardized recital of rates and fees in credit-card agreements—in a field as vast and unruly as climate regulation. And even if some standardization were required, private parties could supply that aggregation. Nonetheless, the SEC is determined to try, without estimating the relative costs and benefits associated with its bold venture.
It would have been prudent for the SEC to start with small steps until it got some experience with how its system works. But the three separate tiers of information required by the SEC go sharply in the opposite direction. Tier 1 involves greenhouse gases produced by the firm itself. Tier 2 involves information from firms that supply the energy needs for the targeted firm. Tier 3 is supposed to encompass all the greenhouse gas emissions of downstream firms that use the outputs later on.
None of these ties, properly speaking, is a disclosure obligation of facts known to key actors inside the corporation. Indeed, what the law requires at a minimum is an extensive system of “investigation” to satisfy the SEC’s very long list of informational demands, which includes information on all “climate-related financial statement metrics” and “extreme weather events such as hurricanes, floods, and tornadoes,” for starters. Then that information must be combined with an account of various transition risks attributable to “regulatory, technological, and market changes.” Remember: these are all firms that operate in global markets, where the information involves hundreds of plants and operations across the globe, many of which use local measurement conventions. But in some cases at least, this information might not significantly vary from firm to firm, possibly leading to duplicate and inconsistent disclosures. Just how do the SEC and private investors plan to audit that information?
The problems get worse once it becomes necessary to make investigations to satisfy the Tier 2 disclosures about the activities of related firms. For large companies with multiple connections, the enormous amount of information could only be acquired by the consent of dozens of suppliers, all of which will be reluctant to reveal their business practices, many of which are protected trade secrets. The Tier 3 investigations are both unlimited and useless, so it may be that the SEC is using them as a bargaining chip to get opponents to back down and accept the obligations in the first two tiers. It should, however, be apparent that the whole scheme goes far beyond the sensible 1930s bargain which the SEC invokes.
In the end, it really does not matter what anyone thinks about climate change or global warming. This purported disclosure scheme—vast demands for largely irrelevant information—collapses of its own weight. A united front in and out of business could persuade the SEC to back off this dangerous gambit, or could go to court to extirpate this nightmare root and branch.Published in