Last week, SEC Chair Gary Gensler gave testimony before the Senate Banking, Housing and Urban Affairs Committee. While his prepared testimony largely revisited familiar themes, the Committee's questioning offered a bit more insight. Committee Chair Senator Sherrod Brown cautioned at the outset that Republicans have "bellyached"-and he assumed would today-about Gensler's "ambitious agenda," but added that, "if Wall Street and its allies are complaining," that means Gensler is doing his job. And right on cue, Ranking Member Senator Pat Toomey cast doubt on recent SEC actions that, he said, raised questions about how well the SEC was handling its responsibility to facilitate capital formation. Where was the SEC, he asked, when some crypto lending platforms "blew up," resulting in billions in losses? And while the SEC has failed to provide regulatory clarity for the crypto market, he contended, it has instead been busy proposing many controversial and burdensome rules that are outside the SEC's mission and authority. After West Virginia v. EPA (see this PubCo post), he warned, the SEC should consider itself to be on notice from the courts. In particular, some on the Committee-on both sides of the aisle-took aim at the SEC's climate disclosure proposal-particularly Scope 3 disclosure-and Gensler's responses made clear that he heard the criticisms, both from the Committee and from commenters, and that there would be some changes to the proposal as the SEC tries to "find a balance." But far would those changes go?
Gensler opened his prepared remarks harkening back to the 1930s, when Congress established the securities laws-the "gold standard," which has "contributed to America's economic success and geopolitical standing around the globe," helping the U.S. to achieve its $100 trillion capital markets. Since then, there have been many new market developments, from new financial technologies to new business models; as "markets have evolved, our rules have continued to evolve as well. That helps us maintain the gold standard." Gensler then addressed the SEC's efforts with regard to market structure (including the crypto market), China, data analytics and issuer disclosure, among other topics. With regard to disclosure, he repeated his refrain about the basic bargain with investors: "[i]investors get to decide which risks to take as long as companies provide full, fair, and truthful disclosures." The SEC, he observed, is charged with oversight of this bargain, which it effects "through a disclosure-based regime, not a merit-based one" [emphasis added]. He came back to that phrase throughout the subsequent questioning to explain and defend the SEC's foray into climate disclosure requirements, which have come under attack as efforts to implement a liberal agenda. Investor demand provides the predicate: "[o]ver the decades," he noted,
"we have updated our rule set to elicit disclosures of information relevant to investors' decisions. Increasingly, over the last number of years, investors are making investment decisions based upon factors that include the risks and opportunities related to climate and cybersecurity. Today, climate-related factors and risks as well as cybersecurity risks both can affect a company's bottom line and its future, and therefore an investor's decision to buy, hold or sell a security or how to vote a proxy. Today, investors are already making decisions based upon information about climate and cyber risks. Hundreds of companies are already disclosing such information, pursuant to disparate frameworks, in a manner that lacks consistency and reliability."
[Based on my notes, so standard caveats apply]
Some Committee members praised the SEC for its efforts on enforcement and its proposals on Rule 10b5-1 (see this PubCo post) and stock buybacks (see this PubCo post), which will provide much needed transparency. On the accounting side, Senator Jack Reed inquired about the need, 20 years after SOX, to revisit the issue of independence of the audit and consulting functions within audit firms. Gensler indicated that he had asked both the PCAOB and the SEC's Office of Chief Accountant to look at updating those standards. He also noted that Acting Chief Accountant Paul Munter had issued statements on this topic. (See this PubCo post and this PubCo post.) In addition, Senator Chris Van Hollen raised the issue, in light of potential investor risk from "sketchy" tax landscapes, of the need for country-by-country reporting of profits and taxes paid. Gensler responded that the SEC is looking at this issue, and there is a FASB project to disaggregate tax reporting in the notes to the financials based on jurisdiction. Committee members also gave the SEC and themselves pats on the back for progress on the Holding Foreign Companies Accountable Act and newly signed Statement of Protocol with Chinese authorities, although the "proof was still in the pudding." Gensler and the Senators expressed support for the pending amendment of the HFCAA that would accelerate the deadline for compliance. (See this PubCo post.) Reed also pointed out that there were now about 1,200 unicorns, and contended that these large private companies should have some type of registration and disclosure obligations. With regard to enhanced human capital reporting, Gensler said that the SEC was currently reviewing two years of experience with the existing principles-based disclosure rules.
The two major topics of conversation, however, were crypto and the SEC's climate disclosure proposal. First, with regard to crypto, several Committee members criticized the failure of the SEC to propose rules on crypto. Toomey said that there were many ambiguities that needed to be clarified by a rulemaking. He suggested that perhaps Congress needs to step in to redefine "security" and calibrate a new framework for crypto. Brown stressed the need to keep the jurisdictional lines clear on this issue; conflicts could arise if multiple agencies were to decide to redefine "security." Gensler responded first that crypto was a very small piece of the capital markets, and he wanted to take care not to upset the whole applecart. In addition, in the views of some Committee members, instead of promulgating crypto regulations that would provide clear guidelines, the SEC seemed to be approaching the issue incrementally through the use of enforcement, individual exemptive orders and one-off discussions-an approach they considered inadequate. Gensler responded that the approach was based on precedent. The SEC had taken that type of long-term exploratory approach before when it needed to develop a regulatory regime for asset-backed securities and ultimately adopted one based on its experience with the issues as they developed over time.
Some of the Committee members enthusiastically favored the SEC's climate disclosure proposal. Brown thought that climate transparency was a good way to reveal that risk; however, comparability and clarity were key, which underscored the need for standardization. Senator Catherine Cortez Masto contended that, to avoid greenwashing, we needed "truth in advertising." Senator Elizabeth Warren contended that the SEC needs to retain the Scope 3 disclosure requirement; if not, companies will simply outsource their high-emission operations. For many companies, she said, Scope 3 emissions represent the preponderance of their emissions. Investors need that information, she said, to understand the risk that may be posed by future regulations that may limit emissions and affect those companies adversely.
But a significant number of Committee members expressed concerns about the proposal, Toomey most ardently. He said that it was no secret that some want to use financial regulation to advance their liberal agendas-a practice he viewed as highly undemocratic because it would be accomplished through the use of unelected bureaucrats. He considered the SEC's climate proposal to be a prime example. Public companies are already required to disclose material information; in his view, the information elicited by the proposal is expensive to obtain and not financially material. In fact, he stressed, the cost of compliance with the rule was more material than the disclosure itself.
As noted above, Toomey considered the climate proposal to be readily subject to challenge under the "major questions doctrine" enunciated by SCOTUS in West Virginia v. EPA (see this PubCo post): given the economic and political significance of the rulemaking, the SEC would need to point to clear Congressional authority. This rulemaking, in his view, seemed to fall easily under the doctrine: the rule would involve a novel approach; would require technical and policy expertise not typically needed by the agency; as a consequential decision, was unlikely to have been left by Congress to the agency; and had previously been rejected by Congress in similar form before. The SEC cannot use a novel interpretation of a statute to "pretend" it has authority. Because, he believed, the SEC did not have Congressional authorization for the proposal, he advocated that the SEC rescind the proposal.
Other Committee members followed suit. Senator Bill Hagerty focused especially on the "crippling cost" and the deterrent effect of the climate proposal on companies that might want to go public. Similarly, Senator Steve Daines characterized the proposal as "beyond unreasonable," imposing "massive burdens" on companies. He did not want to see repeated here the "climate insanity" that is prevalent in Europe and presents an "existential threat" to those economies. Senator John Kennedy interpreted the purpose of the disclosure to be to enable investors to demand a better job on climate itself. He wondered how much all the money spent on disclosure compliance was actually going to lower world temperatures?
Gensler responded that investors need full and fair disclosure of material information, as determined by investor demand. The information would support trust in the market, promote competition and market integrity. The proposal, he contended, is not the same as making climate policy-the SEC is not a merit regulator, but rather regulates based on disclosure. The disclosure to be elicited was intended to help investors, whether they want to invest in green assets or brown. Comments on the proposal from hundreds of the largest investors, he emphasized, indicated that climate disclosure was information that investors want to know, and they want it to be consistent and comparable, because it will matter to future performance around the globe. Currently, many companies do provide climate disclosure, but it's not consistent or comparable. It needs to be standardized. With regard to West Virginia, the SEC took the SCOTUS decision seriously, but he believed that the proposal fell within the SEC's history of disclosure rules to ensure that disclosure was fair and not misleading. Again, he stressed, most of the comments were supportive.
One of the most interesting discussions was precipitated by questions from Senator Jon Tester, echoed in part by Daines and Senator Mike Rounds. Tester remarked that, as a farmer, he appreciates the issue of climate change: because of climate change, in the last two years, his farm had had its two worst harvests ever. But, he said, he also understands the burden of reporting. While a small farm like his would not be subject to a direct reporting mandate, he was still concerned that, under the proposed requirements for Scope 3 reporting, public companies to which he sells his wheat would need to comply, and, as customers, they will be insisting that he provide them with data. But he and other farmers like him don't have the time and ability to provide that data-it will be a tremendous burden. Gensler replied that he understood the concern; this issue had been raised frequently in comments the SEC received. First, Gensler said that it was not necessary for his public company customers to obtain the data from him nor was it the SEC's intent-they could simply use estimates and rely on safe harbors. (But see that, in the release, the SEC identifies first as a data source for Scope 3 disclosure emissions those data reported by parties in the company's value chain. See this PubCo post.) He said they were looking at the comments-and there were plenty in this area-and trying to achieve a balance. He agreed that this topic required a second look to examine the impact on private actors-there was no intent to touch farmers and ranchers. Time will tell how significantly the rules around Scope 3 disclosure are modified to address these issues.
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