The SEC announced late last week that it has abandoned its rulemaking efforts begun last May to compel disclosure of share buyback rationales and data. The turnabout follows an October court ruling that the SEC failed to follow required procedures in adopting the rule and the SEC’s indication in December that it could not cure the defects in the time the court allotted. The SEC therefore announced that applicable requirements revert to those in effect before its rulemaking effort.

The episode not only ends the SEC’s efforts on the share buyback front but bodes ill for the SEC’s other recent rulemaking efforts, including its climate disclosure rule proposal. On the buyback front, state law lets corporations repurchase their shares and leading investors say buybacks can be a rational shareholder-friendly decision. But proponents of the stakeholder model of corporate governance criticize buybacks as harmful to workers or social equality. 

The SEC’s rule required companies to disclose the reasoning behind their buybacks. The Fifth Circuit Court of Appeals vacated the rule because the SEC acted arbitrarily and capriciously under the Administrative Procedure Act by failing to substantiate the rule’s asserted benefit of decreasing investor uncertainty about buyback motives.  

The court reasoned that, if buybacks are not genuine problems for investors, then there was no logical basis for the SEC to compel the rationale disclosure. With an implicit nod to the stakeholder-interests behind the rule, the court found that the SEC never substantiated its threshold proposition that buybacks are a problem for investors.

Concerning the case’s implications for other pending SEC rulemakings, consider the SEC’s controversial climate disclosure proposal. First, courts will insist that the SEC demonstrate that there is a problem to be solved, as its own policies also contemplate. If voluntary disclosure suffices to inform investors of material climate risks, the SEC would be unable to substantiate its premise for the rule.  

Second, as SEC Commissioner Hester Peirce’s dissent from the climate rule proposal said—echoing criticisms of the buyback rule—the SEC is supporting “an array of non-investor stakeholders” demanding changes in company operations.  That is beyond the SEC’s authority, Commissioner Peirce said.

In the share buyback case, the Fifth Circuit also addressed a First Amendment challenge that has implications for the climate disclosure rule proposal. The court held that the buyback disclosure rule did not violate the First Amendment, as it compelled “uncontroversial” and “purely factual” information in the context of commercial speech reasonably related to a legitimate state interest and not unduly burdensome. 

It is less obvious that the SEC’s pending climate disclosure rule satisfies each of those elements. Critics say the proposed rule is not “uncontroversial” because it concerns the effects of climate change and the proper response to it, is not “purely factual” because it requires predicting risks from uncertain future events, is outside any commercial transaction setting, furthers no state interest and is overly burdensome.  

Skeptics of the climate rule will analogize not to the buyback rule, but to the SEC’s ill-fated conflicts mineral rules of a decade ago. The SEC had required companies to disclose whether any minerals necessary to their products or those of third parties were sourced in the Democratic Republic of the Congo or an adjoining country. If so, the companies had to inform the SEC of measures taken to assure that such minerals were untainted by the ongoing regional war—that they were “DRC conflict free.”

In some ways, that “conflict minerals” rule is factual and non-controversial, because the minerals were or were not conflict free. But the court held that the rule violated the First Amendment because the “conflict free” label conveyed a moral judgment implicated by the issues in the Congo war.    

How would the climate rule proposal fare under such a test? In some ways, requiring emissions data is also factual and non-controversial, because the data are the data (assuming they can be reliably measured). But a court could easily hold that the rule violates the First Amendment because climate disclosure, particularly of third parties but even a company’s own when not financially material to it, convey a moral or political judgment and that reducing emissions is a policy goal of the government.  

A counterargument might be that it’s not merely moral or political or controversial, because there is a scientific or professional consensus on the economic and social importance of climate data and abundant investor demand for it. The rejoinder is: the climate proposal compels a political viewpoint that’s controversial because the requirements are not based on a recognized or objective standard of materiality but on a novel and subjective view of what certain large institutional asset managers—and climate activists—say it’s important for investors to know.

As the Fifth Circuit’s abrogation of the buyback rule attests, the rest of the mandatory securities law disclosure system hinges on some nexus between the information and what a reasonable investor would consider important. Fundamentals such as GAAP financial statements, MD&A and other content required in current and periodic reports and proxy statements—along with share buyback information—may be “purely factual and uncontroversial” in ways that emissions and their effects and risks are not.

References
Share Repurchase Disclosure Modernization, Rel. No. 34-97424 (May 3, 2023), 88 Fed. Reg. 36002 (June 1, 2023)
Chamber of Commerce v. SEC, 85 F.4th 760 (5th Cir. 2023)

Chamber of Commerce v. SEC, 88 F.4th 1115 (5th Cir. 2023)

National Association of Manufacturers v. SEC, 800 F.3d 518 (D.C. Cir. 2015).

Hester M. Peirce, Commissioner, SEC, We are Not the Securities and Environment Commission – At Least Not Yet (Mar. 21, 2022)

Sean J. Griffith, What’s “Controversial” About ESG?  A Theory of Compelled Commercial Speech under the First Amendment, 101 Neb. L. Rev. 876 (2023).