SEC stays climate rules: An overview of ongoing legal challenges

On April 4, 2024, the Securities and Exchange Commission (SEC) voluntarily stayed implementation of its recently adopted Climate Disclosure Rules (Climate Rules), which we describe in our first alert in our Climate Rule series, pending completion of judicial review of consolidated challenges to the rules by the Court of Appeals for the Eighth Circuit. In its stay order, the SEC noted that it intends to vigorously defend the validity of the Climate Rules.

In this alert, we explore legal challenges that have arisen within the first month of the Climate Rules’ adoption and provide an update on ongoing litigation and next steps for public companies.

Status of Climate Rule-related litigation and climate disclosures

The historic Climate Rules, adopted by a 3-2 vote on March 6, 2024 after two years of public debate, have garnered much attention. The SEC received over 24,000 comment letters to its proposed rules from numerous interested parties, including academics, publicly traded companies, industry groups, firms, and professionals in the accounting, legal, investment, and climate advisory fields; non-governmental organizations; and federal and state government officials.

Within the first ten days of their adoption, nine cases were filed challenging the Climate Rules. These cases were brought by individual companies, US states, non-governmental organizations, and climate advocates.

Originally, these cases were filed in different circuit courts: four cases in the Fifth Circuit and one case in each of the Second, Sixth, Eighth, Eleventh, and District of Columbia Circuits. Given these various challenges in multiple forums, on March 19, 2024, the SEC formally asked the Judicial Panel on Multidistrict Litigation to consolidate the cases in a single venue, which, under the applicable rules, is decided randomly by lottery. Following that step, on March 21, 2024, the Judicial Panel on Multidistrict Litigation issued a consolidation order of all cases filed as of that date and transferred them to the St. Louis-based Eighth Circuit Court of Appeals. The Eighth Circuit designated a case brought by the State of Iowa as the lead case. To date, no judge has been assigned to the case.

Since the consolidation order, two new cases were filed. One suit was brought by a conservative policy group in the Fifth Circuit and later was transferred to the Eighth Circuit, and another case was brought by two energy companies in the Northern District of Texas on March 28, 2024. The energy companies’ lawsuit is notable as it is the second case brought by these particular companies. The first suit was brought in the Fifth Circuit, which was transferred to the Eighth Circuit pursuant to the consolidation order. According to their complaint, the companies brought suit in the Northern District of Texas in an abundance of caution in the event a district court is determined to have jurisdiction over their complaints rather than the Court of Appeals. It is likely that cases will continue to be filed.

The SEC stated that, notwithstanding its voluntary stay, it intends to vigorously defend the validity of the Climate Rules, and that its previous 2010 climate change-related disclosure guidance, which has been cited in SEC comment letters and enforcement actions scrutinizing climate-related disclosures, remains effective.

Four legal challenges to the SEC’s Climate Rules

While multiple parties have brought lawsuits with varying interests, many such cases raise similar challenges to the Climate Rules. Four challenges raised in the existing suits are discussed below.

Ultra vires: An unauthorized expansion of the SEC’s statutory rulemaking authority 

Opponents have criticized the SEC’s statutory authority to mandate the disclosures in its Climate Rules. The SEC’s rulemaking powers are constrained by the express terms of Section 13(a) of the Exchange Act, its enabling statute. The section provides that the SEC’s authority is limited to mandating public reporting that is “necessary or appropriate for the proper protection of investors and to ensure fair dealing in the security."[1]

In response to the proposed climate disclosure rules and final Climate Rules, opponents argued that the SEC exceeded this authority. Indeed, following publication of the proposed rule, 16 state attorneys general wrote a letter to SEC Commissioner Gary Gensler arguing that “legitimate mandatory disclosures under Section 13(a) are those required to protect investors from inflated prices and fraud, not [those that are] merely helpful for investors interested in companies with corporate practices consistent with federally encouraged social views."[2]

As discussed in further detail below, representatives from ten of those states sued to block the SEC’s final Climate Rules the same day they were adopted.[3]

Interestingly, the states’ position is consistent with the position the SEC took during the Trump Administration – namely that, without specific congressional direction, it lacked the authority to require ESG-related disclosures.[4]

However, the SEC’s position on its authority to promulgate ESG-related disclosure rules changed during the Biden Administration. In 2022, the SEC posited that its proposed climate rules satisfy the requirements of its enabling statute because “this information can have an impact on public companies’ financial performance or position and may be material to investors in making investment or voting decisions."[5] Given the SEC’s reference to materiality, it is likely equating its authority to promulgate rules mandating climate disclosures with its authority to promulgate Rule 10b-5, which prohibits buying or selling securities while concealing “a material fact necessary in order to make the statements made, in the light of the circumstances under which they were made, not misleading."[6] It remains to be seen whether framing the final Climate Rules in this light will convince federal courts that the SEC acted within the bounds of its authority as provided by Section 13(a). Either way, this question may be a source of significant litigation.

The major questions doctrine: The issue’s importance compels congressional direction

One argument raised in recent challenges to the SEC’s final Climate Rules is the “major questions doctrine.” This doctrine is used by courts to unwind agency action where “the history and breadth of the asserted authority and the economic and political significance of the agency’s rule give courts reason to doubt that Congress meant to confer the authority in question.” The Supreme Court has relied on the major questions doctrine twice in the past two years to invalidate administrative agencies’ actions as outside their historical purview and without clear direction by Congress.[7] Following the court’s recent invocation of the major questions doctrine, challenges to agency authority may be expected to proliferate.

Challengers of the SEC’s final Climate Rules argue that they run afoul of the “major questions doctrine” by diverging from the SEC’s historical practice of requiring disclosures only of financially material information. Even within the SEC, opponents of the rules have argued that, in contrast to prior disclosure requirements, the rules “force investors to view companies through the eyes of a vocal set of stakeholders, for whom a company’s climate reputation is of equal or greater importance than a company’s financial performance."[8] Litigants have relied on this perspective to argue that the SEC does not have the authority to dictate what issues beyond financials are (or should be) important to investors.

Notwithstanding recent developments in this area,  the SEC’s final Climate Rules may likely survive a “major questions doctrine” challenge. To start, a court may not view climate disclosures as having the same economic and political significance as mandating actions, such as transitioning power plants away from natural gas and coal. Further, there is perceived to be a longstanding acceptance of the breadth of the SEC’s rulemaking authority.

A First Amendment violation: Impermissibly compelled speech

First Amendment limitations on compelled speech may present another hurdle for the SEC’s final Climate Rules. The “compelled speech” doctrine began in West Virginia State Board of Education v. Barnette,[9] when the Supreme Court held that a state board of education could not require school children to recite the Pledge of Allegiance because the government “cannot enforce unanimity of opinion on any topic.” The Supreme Court addressed the application of the compelled speech doctrine to corporations in Zauderer v. Office of Disciplinary Counsel of Supreme Court of Ohio.[10] Although corporations enjoy protections under the First Amendment, in Zauderer, the Supreme Court held that the “compelled speech” doctrine is not violated by government requirements obligating corporations to disclose “purely factual and uncontroversial information” in their commercial speech as long as the disclosures are reasonably related to a legitimate government interest and are not “unjustified or unduly burdensome.” Thus, historically, SEC disclosure requirements aimed at informing and protecting investors were viewed as compatible with First Amendment protections.

In response to a compelled speech challenge, the SEC may argue that its climate disclosure requirements, like traditional financial reporting requirements, satisfy the Zauderer standard for three reasons:

• The SEC’s final rule would arguably seek only “purely factual and uncontroversial” information about climate risks associated with an offered security
  
  
• The required climate disclosures could be construed as reasonably related to the government’s interest in providing investors with investment-relevant information
  
  
• The SEC’s final rule may not be unduly burdensome because it does not prevent companies from expressing any climate-related message, and therefore does not chill protected speech

There are, however, non-frivolous arguments that the final Climate Rules are different in kind than mandatory financial disclosures, and therefore run afoul of the compelled speech doctrine. In particular, challengers could argue that the Climate Rules compel companies to adopt the SEC’s policy views about climate change and the importance of climate-related risks to investors. This politically charged challenge in the context of climate disclosures might land differently from compelled disclosures of other information.

APA challenge: The agency action is arbitrary and capricious, and is not supported by substantial evidence

Lastly, opponents of the final Climate Rules have raised challenges under the Administrative Procedure Act (APA), which applies to federal agencies and offers procedures for agency rulemaking. The APA allows courts reviewing agency actions to hold unlawful and set aside agency action found to be arbitrary, capricious, an abuse of discretion, or otherwise not in accordance with the law. Under this standard of review, courts assess whether the agency examined the relevant data and provided a satisfactory explanation for its action. If the agency action involved formal rulemaking, as is the case here, courts must also consider whether the agency’s determinations are not supported by substantial evidence.[11]

Opponents to the Climate Rules have argued that the SEC held for decades that it lacks authority to impose broad climate disclosures, and as a result the failure to acknowledge and explain this change in position is an arbitrary and capricious agency action. Litigants have also claimed the Climate Rules should be invalid because there is a lack of substantial evidence that it “will result in improved board and company performance and shareholder value.”[12]

The SEC has countered that there is no change in position, because the Climate Rules are consistent with the agency’s historical understanding of its authority, and a thorough explanation of the expansion of the disclosures is provided in the final Climate Rules. Additionally, the SEC argues that the Climate Rules are supported by academic literature that shows a “well established link between climate-related risks and firm fundamentals.”[13] Nevertheless, it is unclear whether this will be sufficient for the SEC to meet the burden of the substantial-evidence test.

A deeper dive into key Climate Rule cases

As mentioned above, although the Climate Rules have been adopted recently, lawsuits have been brought by various groups, including states, energy companies, and environmental groups. The below are key cases that are being litigated. Notably, three allege that the SEC is overreaching, and the Climate Rules should be stayed or vacated, while the fourth claims the Climate Rules are not sufficient and will not provide investors with enough information on the full scope of companies’ climate risks. 

• State of Iowa, et al. v. US Securities and Exchange Commission.[14] A coalition, composed of nine states and the American Free Enterprise Chamber of Commerce, a pro-business nonprofit, sued the SEC in the Eighth Circuit. This petition claims the final Climate Rules exceed the SEC’s statutory authority and that they are arbitrary, capricious, an abuse of discretion, and not in accord with law. The petitioners request that the court declare the Climate Rules unlawful and vacate them. This case is currently the lead case in the consolidated litigation.
  
  
• Energy company litigation.[15] Two publicly traded energy companies sued the SEC in the Fifth Circuit seeking an administrative stay and a stay pending review of the Climate Rules, which the Fifth Circuit granted on March 15, 2024. Three states (Texas, Louisiana, and Mississippi) and two oil and gas industry groups (Texas Alliance of Energy Producers and Domestic Energy Producers Alliance) have also been added as petitioners. The petitioners allege the Climate Rules (i) fail the major questions doctrine due to lack of clear authority for the SEC to regulate climate change, (ii) are arbitrary, capricious, and premised on evidence that is at-best mixed, and (iii) violate the First Amendment by mandating controversial disclosures and effectively mandating discussions about climate change. In response, the SEC argues the asserted harms are not immediate, as the Climate Rules will not require disclosures before March 2026 at the earliest. Furthermore, the SEC claims the rules fit within its longstanding authority to require disclosure of information important to investors while making investments, and petitioners have not shown that their claimed injuries outweigh the harm of staying rules that will provide significant benefits to investors.[16]
  
  
• State of West Virginia, et al. v. US Securities and Exchange Commission.[17] A coalition of ten states, led by the attorneys general of West Virginia and Georgia, sued the SEC in the Eleventh Circuit. The petition for review alleges the Climate Rules exceed the SEC’s statutory authority and are arbitrary and capricious. West Virginia’s attorney general also stated that the Climate Rules “have some serious first amendment problems as well. We have concerns with compelled speech.”[18] The petitioners request that the court declare the Climate Rules unlawful and vacate them.
  
  
• Sierra Club, et al. v. US Securities and Exchange Commission, et al.[19] The Sierra Club, a nonprofit environmental organization, sued the SEC in the District of Columbia Circuit on the grounds that the Sierra Club and its members cannot adequately manage their investments in public companies without complete information on their exposure to climate risks. This suit alleges that the SEC not only has fundamental legal authority to mandate climate-based disclosures, but that the final Climate Rules do not require sufficient disclosures to protect investors.

Market participants are advised to prepare for an evolving legal landscape

Market participants are encouraged to remain agile and thoughtful about their climate-related disclosures in the coming months and years. While the status of the Climate Rules remains uncertain, prudent public companies will understand both the SEC’s 2010 climate-related disclosure guidance and the Climate Rules. Companies may also conduct materiality analyses of climate-related risks and uncertainties, as well as of the materiality of increasing state, federal, and international regulation of matters such as greenhouse gas emissions, climate and environmental disclosure, and environmental due diligence. Registrants are encouraged to stay abreast of investor disclosure demands and the legal landscape as guidelines continue to evolve.

Read our prior client alert on key SEC climate disclosure rule considerations for public companies. For more information on the final rules or how registrants can prepare for compliance, please contact any of the authors of this article or your DLA Piper relationship attorney.