On Wednesday, in an Expert Forum sponsored by Cornerstone Research, Stanford professor and former SEC Commissioner Joe Grundfest and Vice Chair and Chief Legal Officer of Millennium Management and former SEC General Counsel Simon Lorne discussed “The Evolving SEC Landscape: Jarkesy v. SEC and the Proposed Climate Rules.”  The two seemingly disparate topics were united by a common thread—the intense skepticism exhibited by some courts (including a likely majority of SCOTUS) of the vast power of the administrative state and their undisguised enthusiasm to constrain it.  As Grundfest put it, in a slightly different context, the words are different but the melody is the same. What will be the impact?

[Based primarily on my notes, so standard qualifications apply.]

Jarkesy. In Jarkesy v. SEC, the SEC brought an enforcement action against Jarkesy for securities fraud before an administrative law judge, who found Jarkesy liable and ordered that he pay a civil penalty of $300,000 and disgorgement of $685,000. The SEC affirmed the decision on appeal and Jarkesy appealed to the Fifth Circuit. By a vote of two to one, the Court vacated the SEC’s decision and remanded for further proceedings, holding that the agency’s proceedings were unconstitutional: “(1) the SEC’s in-house adjudication of Petitioners’ case violated their Seventh Amendment right to a jury trial; (2) Congress unconstitutionally delegated legislative power to the SEC by failing to provide an intelligible principle by which the SEC would exercise the delegated power, in violation of Article I’s vesting of ‘all’ legislative power in Congress; and (3) statutory removal restrictions on SEC ALJs violate the Take Care Clause of Article II.”

On the first issue, the Court determined that the SEC’s enforcement action violated Jarkesy’s right to a jury trial: the action did not relate to a “public right” or a statute “that creates a right so closely integrated with a comprehensive regulatory scheme that the right is appropriate for agency resolution.” Rather, the Court concluded, the “Seventh Amendment guarantees Petitioners a jury trial because the SEC’s enforcement action [for securities fraud] is akin to traditional actions at law to which the jury-trial right attaches.”  

On the second issue, the SEC argued that the delegation of authority under Dodd-Frank regarding the use of ALJs was constitutional because its choice of whether to bring an action in an agency tribunal rather than an Article III court was merely the exercise of a “form of prosecutorial discretion—an executive, not legislative, power.” The Court, however, viewed that position as “a misunderstanding of the nature of the delegated power.” Instead, the Court agreed with Jarkesy that “Congress unconstitutionally delegated legislative power to the SEC when it gave the SEC the unfettered authority to choose whether to bring enforcement actions in Article III courts or within the agency.”  That is, by providing no guidance on the issue, “Congress has delegated to the SEC what would be legislative power absent a guiding intelligible principle.”

Finally, the Court held that statutory removal restrictions for SEC ALJs were unconstitutional because, given the substantial executive functions that they performed, the President “must have sufficient control over the performance of their functions, and, by implication, he must be able to choose who holds the positions.”  Here, SEC ALJs were insulated by “two layers of for-cause protection [that] impede that control; Supreme Court precedent forbids such impediment.”

Grundfest predicted that, on the heels of Jarkesy—and an expected epidemic of cases citing Jarkesy—the days of glory for the administrative state were probably behind us. With its impact on a constitutional right, he observed, Jarkesy is a “perfect case to throttle the administrative state.” And given the current composition of SCOTUS and the well-known antipathy of several justices to the administrative state, he said, it seems likely that SCOTUS, if the decision were appealed, would ultimately narrow agency authority.  (See, for example, the dissent of Chief Justice Roberts in City of Arlington v. FCC (2013), where he worried that “the danger posed by the growing power of the administrative state cannot be dismissed.”) And to the extent that the ruling would require Congress to make clear delegations of authority to agencies with clear guiding principles, well, Congress can’t seem to agree on much of anything these days, so gridlock may well ensue. Lorne did not disagree. Moreover, Lorne noted, the implications go well beyond the SEC and the federal securities laws, potentially reaching, for example, the Social Security Administration’s process for determining who is entitled to benefits.

SEC Climate proposal. Both Grundfest and Lorne were hard pressed to come up with any SEC proposal that, in their collective memories, was more controversial than the recent proposal regarding climate disclosure.  (See this PubCo post, this PubCo post and this PubCo post.) Grundfest made clear that, he believed in the threat of climate change, favored climate-related disclosure and believed that much of the information that would be elicited by the proposed rules would be material to investors and markets; however—and it’s a big however—he thought the probability was “exceedingly low” that the proposal—and he appears to be focused here on the quantitative GHG emissions disclosure—would survive judicial review.  As noted above, several of the justices have expressed a strong interest in reining in the administrative state and, in light of that particular enthusiasm, Grundfest said, they “just won’t be able to restrain themselves here.” Lorne also expected that it would be difficult for the SEC to win in court on this proposal. (Note that a wide range of views have been expressed on the question of the SEC’s authority to adopt climate rules.  See this PubCo post, this comment letter from scholars and this comment letter from different scholars.)

In Grundfest’s view, as described in his Bloomberg op-ed on precisely this topic, the

“courts could easily conclude that the SEC lacks statutory authority to mandate greenhouse gas (GHG) disclosures. That authority might instead belong to the Environmental Protection Agency. The logic supporting this conclusion is simple. Not a word in federal securities law—or in the legislative history of those laws—speaks to climate disclosures. The SEC’s authority to mandate disclosures relies entirely on inference from those sources. Those inferences are solid, strong and sensible, and would likely carry the day but for one uncomfortable fact that the commission’s proposal assiduously ignores: In 1974, Congress passed the Clean Air Act, which expressly delegates authority to the EPA to mandate GHG emission disclosures. The EPA has exercised that authority to create its Greenhouse Gas Reporting Program, which already measures and publicly discloses the sources of 85% to 90% of U.S.-based emissions. The federal government thus already requires public reporting of GHG emissions, but through the EPA, not the SEC. The U.S. Supreme Court has explained that more recent legislation that speaks with precision supersedes prior laws that address the same matter more generally. Applying this rule could make it easy for courts to conclude that the Clean Air Act’s more-precise, more-recent delegation to the EPA divests the SEC of whatever GHG disclosure authority it can otherwise claim under vaguer, older securities statutes.”

Opponents of the proposal could also invoke the “major questions” or “major rules” doctrines, which provide that, rules related to subjects with “vast economic and political significance” are unlawful unless, when delegating authority to the agency in question, Congress was very clear in its authorization. In this context, he said, a number of SEC commissioners have been outspoken on their views that the impact of climate change is a crisis of economic and political significance. (See, e.g., this PubCo post.)  They can’t now assert, Grundfest contends, that climate change doesn’t have “vast economic and political significance,” especially in light of Congress’s clear delegation of authority to the EPA. It wouldn’t be a surprise, he observes, “to see the doctrine invoked to reject the SEC’s authority to mandate quantitative GHG disclosures.”  (Of course, in a case before SCOTUS this term, West Virginia v. EPA, SCOTUS is being asked to decide whether, under the “major questions doctrine,” even the EPA has authority under the Clean Air Act to regulate GHG emissions at power plants without explicit authorization from Congress. See this article in the NYT.) 

All this sounds very gloomy for SEC proposal. But Grundfest offers his own pragmatic alternative. Assuming that the GHG emissions disclosure mandate is most likely to be vacated, he advocates two additional alternative rules, consistent with President Biden’s bid for a “whole-of-government” approach: First, he suggests, the SEC should mandate that public companies incorporate into or otherwise include their EPA-mandated reports with their SEC filings. That would avoid duplication of effort and require only de minimis compliance costs. He also noted that, to the extent that other authorities required emissions disclosure (such as the climate bill proposed in California), that disclosure might also be included. Lorne here raised the concern of lack of comparability, which is, in large part, an impetus for the SEC’s proposal. Grundfest replied that we can’t let the perfect be the enemy of the good.  To the objection that the EPA’s requirements do not go as far as the SEC’s, he suggests that, as part of the collaborative effort, the EPA could then “consider more expansive GHG reporting requirements that would capture more emissions data from more sources. These expanded EPA disclosures would also be on forms that easily integrate with SEC reporting requirements.”

Another benefit of this approach, Grundfest observes, is that, while the SEC mandate would apply only to public companies, EPA rules apply across the economy.  Disclosure rules that would apply only to public companies could “incentivize them to sell polluting assets to privately held firms. That’s already happening. Methane traps much more heat than carbon dioxide, and half the industry’s top 10 emitters of methane are little-known oil and gas producers that escape public scrutiny, according to a New York Times investigation. SEC rules can only accelerate the move of the worst polluting assets to the most hidden parts of the market. EPA rules apply economy-wide and don’t contribute as aggressively to this trend.”

Second, during the Forum, Grundfest floated the idea that, in addition to mandating the filing of EPA reports, the SEC could also provide a safe harbor for the voluntary disclosure of additional emissions data that was not required to be disclosed. The safe harbor would provide protection only against private rights of action; the SEC could still sue for “greenwashing.” Many companies already disclose substantial information voluntarily, and this safe harbor might encourage more to do so. (Of course, that type of disclosure might again raise the concern about the lack of consistency, comparability and reliability of voluntary disclosure that prompted the SEC to issue its proposal in the first place.)

“Having the SEC coordinate with the EPA on climate disclosure regulation,” Grundfest’s op-ed concludes, “is a more rational solution to that problem that involves much lower litigation risk for investors and for the economy alike.”

Posted by Cydney Posner