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SEC’s Climate Proposal Tees Up Test of ‘Material’ Info Standard

March 23, 2022, 10:00 AM

The SEC’s proposed climate disclosure rule will likely test the boundaries of a legal standard that the agency relies on to compel companies to produce information that’s material to investors.

The agency’s proposal not only requires publicly traded companies to disclose their own emissions, but those of suppliers and even customers, if they are material.

Tracking such “Scope 3" emissions could require a massive amount of work, said Jonathan Brightbill, chair of Winston & Strawn’s environmental litigation & enforcement practice. If the proposal is finalized as a rule, the SEC will likely need to prove that investors are truly demanding Scope 3 disclosure, he said.

The SEC’s rulemaking faces a long road ahead. A finalized rule, as currently drafted, would almost certainly trigger challenges from companies weary of more and difficult disclosures. Investor interest around environmental, social and governance (ESG) is intensifying. And any legal battle will certainly address how material climate risk information is for investors of all types.

“You could see arguments being made that it is objectively material to investors in certain categories of companies, and utterly and completely irrelevant to investors in other categories of companies, in terms of assessing the reputed financial performance of a company,” Brightbill said.

In 1976, the Supreme Court said in TSC Industries v. Northway that company information is material if there’s “a substantial likelihood that the disclosure of the omitted fact would have been viewed by the reasonable investor as having significantly altered the ‘total mix’ of information available.”

The TSC test has since become the SEC’s default in formulating disclosure obligations, said George Georgiev, a professor of business law at Emory University.

If the SEC finalizes the proposal and is sued, such legal challenges could partially hinge on the test, attorneys said.

Corporations are obligated to disclose material information. But there’s no blanket requirement that the SEC limit its required disclosures to materiality, said Ann Lipton, a law professor and associate dean at Tulane Law School.

Scope 3 Calculations

The proposal’s opponents will likely argue that disclosure of climate risk posed by suppliers goes beyond courts’ interpretation of the materiality standard.

“The argument will be that this information isn’t material in the policy-making sense,” Georgiev said. “I’m curious what the authority they cite will be in that argument. The Supreme Court has never put a limitation on the SEC’s ability to make rules around materiality, and Congress hasn’t either.”

The lack of clear and consistent calculations and metrics for Scope 3 emissions makes a challenge on their materiality even more likely, but it’s unclear how such a challenge would fare. “Due to the slippery nature of materiality, there could be courts that buy it, but it’s a difficult argument to make,” Georgiev said.

If courts are asked to consider materiality, they also must establish what a “reasonable investor” is, said Leah Dundon, of counsel at Beveridge & Diamond.

Legal Challenges

State attorneys general who oppose the SEC’s plans also are hinting at challenging the proposal.

In a June 2021 letter to the SEC, 16 state attorneys said mandated disclosures on climate risk are unnecessary since companies already voluntarily provide environmental information.

An SEC rule states that it’s illegal to defraud someone through a sale of a security, including using misrepresentation of material information. But the rule is “not a freestanding source of authority for the Commission to require climate change disclosures—at least without a showing that they are needed to prevent misleading or fraudulent representations,” the state attorneys said in the letter.

“Rest assured, West Virginia and other states will vigorously participate in the rulemaking process, and, if necessary, go to court to defend against any regulatory overreach by the SEC in the name of climate disclosures,” West Virginia Attorney General Patrick Morrisey said in an emailed statement.

Proposal opponents could also argue that the SEC’s proposal violates the First Amendment because it would force companies to make subjective statements about their operations.

“Some people are dismissive, but there’s a First Amendment and compelled speech issue here,” Georgiev said. “There’s emerging jurisprudence from the D.C. Circuit and the Supreme Court that applies very high standards to what the government can require companies to disclose.”

Still, the current fervor for companies to be accountable to ESG issues and their role in climate change could be a factor in the SEC’s rulemaking and any lawsuits that might follow.

“If they’d done this 20 or even 10 years ago, the SEC would have had less of a chance of succeeding,” Dundon said. “In the last few years, there’s been a substantial move among the public towards dealing with climate change. That might not sway a court, but if the SEC can link climate change to protecting shareholder value, that’ll give them an advantage.”

—With assistance from Lydia Beyoud

To contact the reporter on this story: Dan Papscun in Washington at

To contact the editors responsible for this story: Keith Perine at; Roger Yu at